Last week's title was Volatility High, so this week the focus turns to trading strategies and ideas to consider when volatility peaks. Although COVID-19, crude oil prices, and government fiscal actions remain undefined and uncertain, options and futures indicators began suggesting the oversold S&P 500 Index may have reached a turning point. The Market Review explains, followed by six high volatility trade ideas, three Iron Condors and three Short Put Spreads.

S&P 500 Index (SPX) 2304.92 slid another 406.10 points or -14.98% last week with 324.89 points of the decline occurring on Monday, March 16. After gains on Tuesday and Thursday, Wednesday and Friday's losses pushed it to a closing low for this leg down and importantly below the December 26, 2018 low of 2346.58.

After proposing the media was premature claiming the bull market ended when the major indices declined 20%, Friday's close below the December 26, 2018, 4-wave low at 2346.58 ends the discussion. The uptrend from the March 2009 low illustrated by the third chart in Digest Issue 9 "Big Picture Trend [Charts]" finished Friday. Now watch for an oversold bounce to retrace some part of the 1097.96 point or -32.35% decline from the February 19 intraday high to Friday's intraday low.

CBOE Volatility Index® (VIX) 66.04 gained another 8.21 points or +14.20% last week after reaching an intraday high of 85.47 on Thursday as SPX turned up and closed 11.29 points higher.

Our similar IVolatility Implied Volatility Index Mean, IVXM using four at-the-money options for each expiration period along with our proprietary technique that includes the delta and vega of each option, added 6.35 points or +12.10% to end at 58.81% after spiking up to 77.15% on Monday as the SPX declined 324.89 points on the day.

Then, with quarterly options and futures expiring on Friday, it ended back down at 58.81%. Since the spike up to 71.58% on Thursday, March 12 was not the peak, then last Monday's spike to 77.15% will probably hold the record for this market decline.

VIX Futures Premium

This next chart shows as our calculation of Larry McMillan’s day-weighted average between the first and second-month futures contracts as of last Friday.

With 17 trading days until April expiration, the day-weighted premium between April and May allocated 85% to April and 15% to May for a premium of -7.26% still in the bearish red zone but moving back toward the normal zone. The Friday before it was -20.86% ahead of options expiration when the near term future remains abnormally high then collapse on Monday and Tuesday. For a better comparison the volume-weighted version was -15.76%, still in the red zone, but not quite as low.

The premium measures the amount that futures currently trade above or below the cash VIX, (contango or backwardation) until front month futures contract converges with the VIX at the next futures expiration on Wednesday, April 15. When the VIX declines, the premium will increase back toward the yellow zone between zero and 10%.

For daily updates, follow our end-of-day volume weighted premium version located about halfway down the home page in the Options Data Analysis section on our website.

High Volatility Trades

Of the several high volatility trading strategies two of the less complex ones that will benefit as implied volatility declines are Iron Condors and Short Put Spreads.

Iron Condors are a four-legged combination strategy consisting of two credit spreads, an out-of-the-money call credit spread along with an out-of-the-money put credit spread. They have the most potential for gain when the underlying is in a range and the options implied volatility is high. Look for large well-managed companies with high stock and options volume that have recently declined due to changing market conditions rather than a specific company issue. Higher prices stocks will produce a greater net credit.

Although it involves four legs and more commissions than a simple combination of a short call and short put, using spreads on both sides has the advantage of defining and limiting the risk. There are many stories about traders that failed to use spreads and lost it all when one side or the other made unanticipated large moves.

With implied volatility at levels not seen since 2009, there are many attractive candidates in all sectors. Here are just three examples of stocks that appear near the middle of their 52-week trading ranges.

Ranked by potential decline of implied volatility assuming regression to the mean, where IVXM is the implied volatility mean on Friday, March 20, IV Range is where the current implied volatility closed relative to its 52-week range, Reg. Mean is the implied volatility regression to mean, and Potential % is the change in implied volatility assuming it returns to mean at some future time.

Using TSLA as an example since it has the highest price and will, therefore, produce the largest initial total credits for the two spreads.

With a Historical Volatility on Friday of 127.49 and 94.04 using the Parkinson's range method, the Implied Volatility Index Mean was 134.98 at .84 of its 52-week range. The implied volatility/historical volatility ratio using the range method is 1.44 so option prices are moderately high relative to the recent movement of the stock. Friday’s option volume was 601,197 contracts with a 30-day average of 508,380 contracts with reasonable bid/ask spreads.

Short Call Spread,

Buy April 17 650 call at 7.65(ask) IV 112.73
Sell April 17 600 call at 10.85(mid) IV 110.59
= 2.83 credit

Short Put Spread,

Buy April 17 200 put at 8.95(ask) IV 218.63
Sell April 17 250 put at 14.68(mid) IV 195.76
= 5.73 credit

Using the ask price for the buys and mid for the sells the combination net credit would be 8.56. In the event it opens considerably higher or lower, adjust the strike prices accordingly. Ideally, the spreads should be above and below the tops and bottoms of the 52-week range of the stock but the premiums and options liquidity will diminish so it means accepting some price risk. Should the stock price reach either spread by expiration, the other spread will be worthless, so there is risk only on one side.

Selling Put Spreads are a modified version of cash covered put sales where the risk is defined and limited. While just selling puts when implied volatility is high will produce a greater credit it also has the risk of being put the stock at expiration. However, it can also be strategy to reduce the cost of buying the stock at some predefined P/E level expecting to receive the stock.

Usually when implied is low, short put spreads produce very little credit, but the opportunities increase when implied volatility increases like now.

Three examples raked by their potential for implied volatility to return to the mean.

Although MCD has the highest potential assuming implied volatility regresses to the mean, the April 17 bid/ask spreads are so wide they consume most of the spreads.

QCOM with a lower stock price and reasonable bid/ask spreads makes a good example.

With a Historical Volatility on Friday of 94.86 and 63.38 using the Parkinson's range method, the Implied Volatility Index Mean was 74.54 at .89 of its 52-week range. The implied volatility/historical volatility ratio using the range method is 1.18 so option prices are modest relative to the recent movement of the stock. Friday’s option volume was 24,965 contracts with the 30-day average of 23,380 contracts.

Buy April 17 52.5 put at 2.34 (ask) IV 84.03
Sell April 17 57.5 put at 3.60 (mid) IV 75.84
= 1.26 credit

Caution: Although implied volatility looks as if may have peaked, Mondays have been exceptionally weak and this one could be another depending on the news over the weekend. If so, it's back to the drawing board waiting for the next peak.

Strategy

Begin considering opportunities to sell high priced options using strategies with limited and defined risk.

Summary

With last week's closed below the key S&P 500 Index level of 2346.58 leave us no choice other than to reluctantly join the financial media and declare an end to the bull market run from the March 2009 low. However, now extremely oversold a retracement bounce could occur at any time and some of our volatility indicators suggest it could come soon. As options implied volatility begins declining, consider high volatility trades like Iron Condors and Short Put Spreads.