When I became interested in learning about Options I didn’t know anything about “volatility.” Although options appealed to me, as a new retiree, for risk
management of my investments, the full education as a student at OptionsANIMAL opened many topics that have served me well as a conservative investor,
including VOLATILITY! As the general market goes through the up and down cycle the value of options go through a cycle, too.
Value of Options may be split into two main categories; intrinsic value (only found within in-the-money options) and extrinsic value (included as part of
the value of in-the-money options AND out-of-the-money options.) The extrinsic value of options is based on a small list of criteria: stock price, strike
price, time, risk-free interest rates, dividends (if there are any) and implied volatility. If anyone looks at the Black-Scholes model which tells us how
to estimate the individual pieces of the options value, it’s clear that all separate characteristics except the IV (implied volatility) value is easy to
find. I view IV as the Wild Card of options where it can trump any other characteristic of options value.
One problem with options I learned about is the “threat of volatility crush.” Did you know that if you are a buyer of options when the IV is in a high
range that you could suffer a capital loss in the option, even if the equity moves in the direction you expected? Volatility crush is a potential threat
for option buyers only, not option sellers. Add this fact to the basic definition of long options and short options. Long options give any holder RIGHTS,
whereas short option holders take on potential OBLIGATIONS. To fully understand risks and rewards that may come with any combination trading strategy that
includes long options, tracking the range of the past year of implied volatility is a fine habit to stick with. That goal is to easily answer one question.
“If that option is carrying a threat of volatility crush what can I do to avoid being a painful victim?”
There was an interesting book published by two fund management this year that I enjoyed reading. I couldn’t help but chuckle when I read that they made big
investments in 2011 in an attractive new stock, Molycorp, Inc. They reported that they took a big loss when it only went to a rising price early and then
caved in to a much lower price. As an options investor I also entered MCP’s long stock position, yet added options to protect myself. I was given a huge
advantage to boost my results with the spike in implied volatility during the year. Although I had bought the stock at $57.70 per share and sold it eleven
months later at $29.10, I ended up with a 29% profit by taking advantage of IV in short options. A key thought in position holding is to
follow the stock chart daily, review the full risk in the trade, know how to modify the position in order to lower risk, and understand what
characteristics are being given nice benefits.
I was spending some time in Denver, CO this weekend sharing some of my experience in conservatively adding options to long stock to manage risk and boost
profits. After I ate dinner Friday night I was given a fortune cookie which said, “Help people reach their full potential.” How interesting. I thought back
to years in my life where I didn’t understand options investing at all. I never would have imagined that volatility would be an important thing to study.
I’m very thankful that there were fine folks who helped me open my mind and take in such good information. I sure hope I can pass this on to others now,
too!
Emilu Bailes
OptionsANIMAL Instructor
Options Trading Resources
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