Condor Options

In absolute terms, equity implied volatility is as low here as it’s been for ages. A naive reaction to a decline in implied volatility is to take a long volatility view by buying straddles, strangles, etc. on the expectation that implied volatility will revert to a higher long-term mean. But that’s an easy way to go broke as the market continues to drift, especially since implied volatility has carried a hefty premium to short-term realized volatility for many months now. To clarify: one-month historical volatility in the S&P 500 is around 7% annualized, while at-the-money April SPX options prices imply volatility in the range of 13-14%. A trader who wants to take a long view on future volatility (whether implied or realized) has to overcome that 7% premium she’s paying just to break even, with profitability coming only thereafter.

My colleague at Expiring Monthly, Adam Warner, notes that in this environment, options are actually quite expensive. No matter what intuition says – no matter what’s happening with implied volatility in absolute terms – the relation of implied to historical volatility here is such that the best approach is to sell option spreads. Adam suggests trading iron condors, which, obviously, sounds like a reasonable approach to me.

This is one of the benefits of trading a predefined strategy with mechanically generated signals: human intuition, and discretionary opinions in general, can be wholly misleading and woefully unreliable.