Greg: Good morning everyone. Welcome to OptionsANIMAL. This is Greg Jensen glad to be with you today. I’m excited you took some time out of your day today
to come and learn a little bit about volatility. I do a lot of these different webinars from time-to-time with different experts in the market from TV
celebrities to Chicago Board of Options Exchange, different brokerage firms, and what not. I’m as excited today about any of them because I’m going to
introduce to you someone who is as knowledgeable about volatility and the VIX as almost anyone I’ve ever met in the industry.
The other thing I really like about Eric is the guy actually trades. He’s a really good trader. Eric, glad to have you here today. What I would suggest to
those of you who are here, we’re going to try to cover the concept of volatility, ask questions if you’d like to in the question bar. We’ll try to get to
as many of those as we can. We’ll try to make this as information packed of an hour as we possibly can. Without further ado, Eric, I’ll turn the time over
to you and thanks for coming.
Eric: Hey, Greg. Thanks I really appreciate the opportunity to be here to share this. You know as well as I do this is an area that I’m very passionate
about. I’m passionate about trading. I’m passionate about educating people and helping people. Understanding volatility is something that I think I do have
a very good understanding of. One of my skills is my ability to help people and help others. We’ve helped thousands of people learn and become successful
Today I’m going to talk about volatility. Within an hour I’m going to do my best to stay on time so we’re going to move at a pretty good pace, so please
pay attention and we’ll make sure those who that have questions we’ll get ways to get your questions answered if we don’t get to them live. This is going
to be pretty fast paced. We’re going to cover a lot of content and I’m going to go through it at a pretty brisk pace.
Before we start let me remind everybody of our disclaimer that all rights are reserved and copyrighted to OptionsANIMAL. The content of this presentation
should not be considered a recommendation of to buy yourself security. All information is intended for educational purposes only and in no way should be
considered investment advice. Options involve risk and are not suitable for all investors. All rights and obligations of options should be fully understood
by individual investors before entering a trade.
As we like to say to our students, make sure you always define your primary and secondary exists with every trade. It’s the secret to being successful in
trading. Let’s go over our agenda. We promised to talk about volatility and the VIX. I will say that our marketing people get a little creative and we’re
going take an hour and teach you everything that you need to.
I’m a realist. We can teach you a lot and I guarantee you that everybody listening to this is going to come a way with more knowledge. You’re going to
learn something. Everybody listening is going to learn a little something that you didn’t know. Some of you will learn a lot. I don’t think I can teach you
everything about The VIX. If I had a week, I probably could teach you everything about the VIX and volatility. I could teach you a lot but we’re going to
cover a lot.
The agenda we’re going to talk about what affects option pricing because options is really what this is all about. We’re going to talk about the two
different flavors of volatility. We’ve got historic volatility and implied volatility. In order to be able to understand implied volatility you need to
understand historic, so I’ll make a clear distinction between the two and you’ll come away with a good understanding of those.
Then we’re going to introduce the VIX and of course we’ll wrap up with an overview of who we are and how we help our students become more successful. What
affects option pricing? You buy a stock and what affects stock price? Only one thing affects the stock price, that’s the stock price. It seems redundant
but it’s true. When you trade the options, there are multiple things that affect the price of options and in order to trade options you have to understand
what makes the price change. What are those?
You’ve got the option pricing. The two most obvious things are the strike and the stock price. You buy a car or you buy a put. It has a timeframe, that has
a strike price and that’s where we exercise the contract. That’s where you have the right in the case of buying and an obligation in terms of selling
options at the strike price. Now, obviously the stock price is going to impact that option whether it goes up or down. Once you buy the options the strike
sets of the stock price, that’s the most obvious if people understand that coming into us.
The next one is time to expire. That’s usually the next one that people get a handle on and options folks, you can think of options as insurance. If I buy
insurance for a month or I buy insurance for a year, obviously the price is going to be different. That’s exactly the same analogy with option. If you get
an option that expires in a week, it’s going to cost less than an option that expires in a year. Time has an impact on the option value.
The third one and the one that people come to understand what I really want to focus today on is implied volatility. Implied volatility in a nutshell just
represents risk. The risk of movement actually it’s what it is. It’s not bullish, it’s not bearish. It’s just associated with the risk of that stock
Interest rate and dividends, now we don’t see those two change very much of course with the fed having its policy for the past four years of keeping the
rates down. The risk free interest rate doesn’t really change dividends. It does affect option prices around the ex-dividend date. We’re really not going
to focus on those.
The three big ones here are the stock price, time to expire and implied volatility. If you can trade at options you have to understand all three. Let’s
look at option pricing. Option pricing can really be broken into two components. The two components are one; the intrinsic value, and that is the amount by
which an option is in the money. The second component of option pricing is extrinsic value. The extrinsic value is everything above and beyond the
If we were to calculate the price of an option, we know what the price is we can go look at an option change, we know what the price is. If you want to
figure out what the intrinsic value is, we would subtract the stock price where it’s trading now and the option strike. It’s either you subtract the strike
from the price or price from the strike depending if we’re talking puts or calls. It’s just how far it’s in the money. The option price is the combination
of those two things, the intrinsic value and extrinsic value. How do we … calculating intrinsic value is easy. How do we calculate the extrinsic value?
The extrinsic value is equal to the option price minus the intrinsic value. That’s how we come about and get to the extrinsic value. Now, let’s look at
what impacts intrinsic value. I’ve said here the intrinsic value is equal to how far in the money the option is. When you look at an option chain, you’ll
see a section that is grayed out usually depending on your broker. The grade out section are in the money.
Strikes that are lower on the call side are in the money, puts higher strikes are in the money. The only thing that tells you what the intrinsic value is
by looking at the difference between the two. Those are the only two things that impact the intrinsic value of an option. It doesn’t matter if the option
expires today or in three years from now. Time doesn’t matter. Volatility doesn’t matter. The only thing that matters is how far in the money it is. It’s
just strike and stock price. In the money options the intrinsic value is the difference between the strike and the stock price. It’s pretty simple.
Out of the money options have no intrinsic value. Another way to think about this if you get confused is think about what would my option be worth today if
it expired, if it was expiring today. If it’s out of the money it’s going to be worthless. If it’s in the money you can think about what’s the minimum that
this money would be worth and that’s how you come up with the intrinsic price.
I like to use a lot of analogies as you know when I teach. Some of my students will tell you. Some like my analogies, here’s one I think that helps and I
can relate to and hopefully maybe some of you can relate to.
It’s a cold day today in Chicago but it’s never too late to have a beer or too early to have a beer, no. I like to look at the two components if you
imagine this beer as being the option price, and the two components are the liquid portion which should be the intrinsic and the foam which should be the
extrinsic value. The foam represents everything that’s above and beyond. If you poured a beer off a drought, around of a can you’ll know that the head’s
going to be bigger at then end and as you wait it gets closer and closer the expiration if you will. That foam goes down.
Now, I could things like I could toast somebody. I could put a straw in and it blow bubbles and that foam goes up and down, maybe I put some salt in it the
foam goes. Your option pricing can change, that extrinsic pricing can change, but the intrinsic thing that only happens with that is when I actually drink
the liquid that make it go up and down.
This helps with some people to imagine the Extrinsic value as the frothy portion of the option pricing. Seven degrees in Florida. It’s snowing like a
[Venchi 00:10:09] right here in Chicago. We’re getting an inch, 1½ inches. My backyard looks like a winter wonderland right now.
Here’s an example, let’s look at option pricing. This slide is a little bit old. I hear some people say a lost audio can … Other people tell me they hear
me okay. I see some people in chats saying they lost audio. I see my microphone moving so a bunch of yeses, okay, good. This is an options chain. Research
in motion at $61 that would be nice if it was back, nice or bad doesn’t matter. It was taken a while ago.
The concept’s still the same. It doesn’t matter what equity this is. Let’s look at the puts. Let’s look at the price of the puts. Here is the ask price and
you can see the numbers there, you see these are out of the money. Remember I showed you the shaded portion. Here is where the shading is. This is $61.09.
All the put strikes that are higher than $61.09 are in the money. All of these shaded ones are in the money puts. Here’s the price. All of these are out of
What’s interesting is 100% of the price for out of the money options is extrinsic. Options that are out of the money have no intrinsic value. Some people
are, “Why are you harping on this intrinsic, extrinsic thing?” I want you to be able to get a feel for how those two components move. That’s what I’m going
to do. I’m going to help you understand how those two components … If you can understand those two components and how they change; you’ll have a better
understanding of option, option pricing and what affects option pricing.
Let’s take that data and plot it. I was messing around and this is exactly what I did. I took that data and I put it in Excel. That’s cool. I see a curve.
That doesn’t really tell me much. What am I really looking at? Let’s break this down and look at the extrinsic and intrinsic pricings. The extrinsic and
the intrinsic. The black portion that you see here is the intrinsic price. The green portion that you see is the extrinsic. Looking at this curve, what do
you see? One of the things that was interesting to me is that that’s a straight line.
You’ve got a curve with a pricing here but I got a straight line on the intrinsic portion which makes sense. The only thing that impacts the intrinsic
portion is how far it’s in the money. Right exactly where it intersects this line is zero would be equal to the price. You remember where this thing is
trading? $61.09. This would be exactly $61.09. If I had a strike at $61.09 it would be exactly where the intrinsic value is zero. That would be at the
money strike. Intrinsic is pretty easy to understand.
The only thing that impacts it, once you’re on the option is whether it’s in the money or out of the money and that’s the only thing that impacts, is the
stock price. Let’s get rid of the intrinsic and let’s just look at the extrinsic pricing. If I plot the extrinsic pricing here, what do I see? I see a
shape that maybe a lot of people recognize. That kind of looks like the infamous bell curve. Folks, this is real data. This is not philosophy. This is not
theory. This is real option pricing. This is nature. This is what the market sets out there. This isn’t some textbook or something. This is real data.
What you notice is that the peak is at the money. That’s where it’s trading. That’s where the maximum extrinsic value is. That’s a key takeaway right
there. The maximum extrinsic value will be at the money. Occasionally, with some bizarre options you see some weird things happen on different options but
normally this is the case. Sometimes there’s low liquidity and some strains. Don’t worry about that. Most of the time this is the case and the vast
majority of everything you deal with, the extrinsic value is going to be greatest at the money.
This is statistics, yes it is. What we can we think about with regards to extrinsic value and what I’m going to tell you right now is one of those key
takeaways. Stop looking at CNBC right now, stop reading your email and focus on me for a second. This is a key takeaway right now. The extrinsic value
reflects the probability that an option will expire at the money. Don’t worry about the absolute value. Is it five? Is it one? Is it two? Is it 0.5? Don’t
worry about the number. Just realize that the extrinsic value is a reflection of the probability that a specific option will expire at the money.
If I had to hold a gun to your head right now and said, in a month what strike is going to be at the money? The stock’s trading at $61.09. If you had to
make a bet on the last box of Twinkies in the world. That’s what I’m holding hostage here. I’m going to take it from you if don’t get the answer right.
What’s the best guess of where the option’s going to be? It’s where the extrinsic value is the greatest. It’s the $60 strike. That is why it has the
highest extrinsic value, because it has the greatest probability of expiring at the money.
Look out here at this $80 or the $75. What are the chances that the stock is going to get to $80, so $80 becomes at the money strike? Not very good. It’s
really small. Can it get out to $80? Yeah, something can happen. Could REM] move? Maybe with REM we should be down here on this end. Could it move $20?
Yeah, absolutely. The stock could move $20. Probably not going to happen but what if, let’s say this is a 30-day option. What if I made this a one year
If I’m looking at this chart now, I’m looking at it saying, “In the next 30 days, what are the chances that the stock is going to get … What are the
chances that the equity is going to move to $80 in 30 days? Pretty small. What if I now looked at an option that expired in a year? You’ve got a greater
chance of the equity moving to $80 in a year than you do of the equity moving to $80 in 30 days. That increases the probability that $80 could be at the
money and therefore the extrinsic value would increase.
Here’s an extra credit one for you folks. What if earnings was coming up? Right now let’s say earnings isn’t coming up. What if all of a sudden [Tharst
& Hynes 00:18:04] comes out and says, “We’ve got a major new product announcement.” What do you think is going to happen to the option pricing?
The stock may not move. The stock probably won’t move. What would happen if there’s a major announcement? Let’s just say [Tharst & Hynes] says, “We’re
going to have a major press conference. We’re going to release some really big news.” It could be a product announcement, it could be an acquisition, it
could be they found out Blackberry is giving you cancer or something like that.
What’s going to happen if there’s some big announcement? You’re going to see the option pricing increase because there’s a catalyst. What I want you to
take away is this understanding that the extrinsic value is a reflection of the probability that that specific option will be at the money. We talked about
time. We talked a little bit. We just talked about there with the earnings or some big announcement coming up. That’s actually implied volatility. I’m
going to go into that a little bit more. I’ll come back to it. What’s another thing that could increase the probability of the $80 being at the money?
This one’s obvious and it’s almost too obvious, you’re going to be mad at me. What if the stock moved to $80? My whole curve here would shift. $80 would
now become the at the money strike and the extrinsic value, the extra value would increase on that $80 strike. It would have the greatest extrinsic value
if the stock price were to move to $80.
Here’s an extra credit for you; did I make money or lose money if that happened? Remember we’re talking about puts here. You would actually lose money
because on this slide I’m not showing the … maybe I should just back a little bit.
If the stock moved 80 remember that would be at the money so the intrinsic value would come down to here, the extrinsic value would go up. If the stock
moved to 80 I would lose money on this put which right now is costing maybe $19. If my extrinsic value would probably go up to $3 or $3.50, but my
intrinsic value would go to zero. I would end up losing money. I lose like $15 on that trade but my extrinsic gets bigger. If the stock went down that
would be other effect.
Anyways, I just wanted to go over and hopefully help you guys really get a feel for intrinsic and extrinsic. I’m going to start talking more about, so the
question is at the money. Somebody asked the question what’s at the money. At the money is the strike that is closest to where the stock is trading now.
Whatever strike is closest to where the stock is trading now is considered to be at the money strike. In order to understand implied volatility which I
introduced a little bit here, you really have to understand first historic volatility.
Let’s talk a little bit about historic volatility. I’m going to come back to the intrinsic, extrinsic stuff. I want to let that soak in a little bit, let
you guys mole on that. Let’s talk about historic volatility. Here’s three equities that are all trading with an average price over the past 30 days in 100.
The average price on all of this is 100. I know that because I put into Excel myself and I made them equal 100. You can tell these are completely different
equities. They have different behaviors and volatility I like to say is like pornography.
You know it when you see it. Which one of these is more volatile? You all probably can guess. Everybody is going to say C or C is the most volatile one.
Which one’s the least volatile? B, bravo would be the least volatile.
How do we measure? You can’t just swag it, you got to have some way, some objective way. The way that we do that is there’s a number of different ways to
measure historic volatility, but one of the more common ways is to use a standard deviation. It’s a term from statistics and it measures how far it goes
from the mean. That’s what this is.
Those of you that took statistics may want to know that this is … we actually use algorithm over the next 30 days. You don’t need to worry about that
unless you want to do the calculation yourself and you want irk out on the math, which we can do but I don’t want to sidetrack us on that. I’m just saying
that to be complete. We look at the standard deviation over the past 30 days is what’s typically done. We can look at two weeks. We can look at 300 days;
30 days trading days is what tends to be done.
If we were to put those in numbers, we can get an objective number and it gives us for each on these, so you can see that C, Charlie here has a 56.9%
standard deviation. Then B is the lowest at 7.3%. Let’s look at this in a different way. Let’s look at a stock over a period of time. Now we’re going to
look at A particular stock over 90 days.
Those of you that remember patterns might notice that there is three distinct phases on here. I’m going back a slide so these numbers might come back
again. The way that historic volatility works is we don’t actually get a number until we’ve had 30 trading days go by.
We’re doing this calculation for this box of time here. Then we roll forward day by day to another period and you can see 30 days later during this period,
you can see the volatility has dropped down to a relatively low period and now we’re about to enter into a higher volatility phase and we get into that.
That’s how historic volatility is calculated. Let’s look at some real numbers. Price versus historic volatility, you can look in here. The black dots are
the SPY. You can look in this period and you could say, “Yeah, that’s volatile.”
It looks like it’s not very volatile in this period and then it gets a little more volatile. You could see the volatility; the purple line is the
volatility. You can see it going up and down. An interesting thing that happened here is this is drop.
By the way, I just did this on Sunday; this data came on Sunday. It’s got all but the past few days trading in it. You notice a couple of big changes. Does
anybody know what time that correlates to? That was the fiscal cliff. As of the first of January, first trading day of January we had a couple of big days
up. Those were volatile days. High historic volatility.
Not a bad kind of volatility here because it went up. If you’re bullish it was good for you, right? What happened is, remember this box that calculated 30
trading days. These two points that you see being added a lot of volatility into this thing and then 30 days later those come out of the calculation. You
see this drop down in implied volatility that happened because these two days were no longer in the calculation. Let me show that a little bit more
Here’s a favorite one, Netflix I like to talk about. Looking here, look at this big gap. The stock went from somewhere in the 80’s down to about $60, a
huge loss overnight. We saw a big jump up in historic volatility. Then we see a dropdown and then another drop down. Look at this period in here. Was there
anything noteworthy on the volatility in this period here? We use my laser pointer, was there anything particularly noteworthy about the volatility here?
Why did the historic volatility go from 80% down to 40%? The historic volatility went in half overnight. Why? This gap is no longer in the calculation.
This is one when I listen to people who are so called volatility experts do a comparison of saying that, “I like to compare the historic volatility.”
That’s my voice for people who don’t know what they’re talking about sometimes. “I like to do my comparison of the implied volatility to the historic
volatility.” Yeah, well what did this tell me when the historic volatility? Historic volatility was 80 now it’s down to 40, so what? Who cares? It doesn’t
mean anything. It means something happened 30 trading days ago. It means nothing about what’s going on.
Certainly an increase in historic volatility means something. This is Germaine. This is today yes, I saw a big jump up. The jump up means something but the
jump down doesn’t mean anything other than the calculation, that gap. This gap here is no longer there, who cares. You got to be aware and understand
people will talk about I’m comparing historic to implied. It might be okay to do that as long as you understand what you’re doing. I’m amazed at how little
some people … Lets just leave it at that.
Here’s Netflix. I gave you a little bit of an insight into historic volatility. Let’s change gears and go to implied volatility. Implied volatility has the
word implied into it. Implied volatility is the volatility that’s implied to happen over the life of the option.
It represents the risk of future movement. It’s not bullish or bearish. It just measures what’s the potential for a move in the future. It’s just a measure
of risk. I used an analogy of beer earlier. Let’s use an insurance analogy I like to use. Homeowner’s insurance.
Let’s pretend that you’re an insurance company, right? Somebody comes to you and says, “Listen.” Two homeowners come to you and say, “Listen, we need to
buy insurance. My house is worth $500,000 so I want a contract.” In this case you’d be selling them a put. That’s what a put is. It’s home owners insurance
on your stock. If your stock catches on fire you have insurance. That’s what a put is. Which gets me, when people tell me, “Trading options is risky.” “Is
owning homeowner’s insurance risky? I think that’s actually the opposite of risky. That’s the safest thing to do.”
Actually trading options, if you don’t know what you’re doing can be pretty risky, but if you appropriately use options, you are doing something that’s
less risky. Buying a put contract to protect your home is a good idea.
Let’s say that you’re the insurance company and each person comes to you, each home owner says, “I need a one month and I want my deductible to be $500.”
“Where are the houses?” “One’s in Cleveland and one’s in Miami. How much do you charge?” Can you answer the question? No, you probably need some more
information. You send your assessor out and your assessor sends back these two pictures.
Here’s the picture in Cleveland, that’s a nice house for $500,000, but again this Cleveland. Nothing against Cleveland, I like Cleveland. Let’s not talk
about Lebron James though. 123 Happy Avenue, Cleveland Ohio. Here’s 666 Stormy Way in Miami Beach. Both houses $500.
By the way this is going on. Who pays the higher premium? It’s not rocket science. Maybe coming up with a number might be rocket science or actuarial
science. Intuitively you know who should pay more money. The relationship here that I’m talking about is when there’s a storm on the horizon, no damage has
occurred. I’m just looking at the weather.
Literally, if you were the insurance company and you knew this was happening, they called and said I need a month of insurance or I need a week of
insurance. You’re going to charge them a lot of money for that week, right? Because you know there’s a potential that some damage could happened.
That’s what implied volatility is. It looks at the future. It looks at the weather forecast and says, “What can happen between now and the expiration of
that option? When implied volatility increases, options increase. By the way calls increase as well as puts. Implied volatility increasing is a significant
thing for you.
This is the closest thing that option traders have to a crystal ball. It is a tremendous edge that you as an option trader have over an equity trader.
Equity traders do not understand. It’s not that difficult. I just explained it to you. I bet half of you didn’t understand what I just … Before I said it
you didn’t understand. Now you’ve learnt something.
Getting in tune to understanding implied volatility is a big deal. That’s actually one of the things we do here at OptionsANIMAL; teach you how to manage
that, protect yourself and actually take advantage and make money from those changes. Prices of options increase, calls increase as well as puts.
Two reasons, one is that implied volatility is not bullish or bearish. It just says the stock can move. It could go up or it can go down, I don’t know. Go
back to that chart that I showed you on Netflix and you’ll see that there were to big spikes in there.
One was a bullish spike, one was a bearish spike. Implied volatility doesn’t know which way its stock is going to go. It just knows that it’s going to go.
The other reason why both calls and puts is because of the synthetic nature.
What that simply means in English is that I can be bullish with puts; I can be bullish with calls. I can be bearish with calls; I can be bearish with puts.
I can construct trades on either side. With the implied volatility gets too out of work on one side, I just go on the other side and do the trade on the
other side. I can get the same risk profile that I want.
The two options will tend to go up and down together. Implied volatility on calls goes up as well as puts. Increased implied volatility when the options
get more expensive because … Go back to the concept that I introduced about extrinsic value. Remember I told you to focus and listen to me?
Extrinsic value is related to the probability that that strike will expire at the money. Anything that increases the probability of an option expiring at
the money, anything that increases the probability of a specific option expiring at the money will increase the extrinsic value of that option. Let me show
you in a picture.
This is a Trade Monster has some cool tools that are out there. This is one that you use on the strategy tab that shows you. This is the volatility cone
it’s called. I can set the implied volatility forecast here and it shows me a range of where the equity can move to.
There’s probability, you got a 1% chance of it getting here or here. You got a 5% to 20% chance that it’s going to be on this range. You got a picture of
that cone. I can come in here, type in and change this number. Look what happens to the cone. Let’s say that I made this 50, made it equal to 50, implied
volatility of 50.
That shows you what the market thinks is a good range for this thing to move at. You think that’s helpful? You think you can use that in your trading? As a
minimum you better understand this if you’re going to trade options.
I’ve seen the price of options double or triple or go in a half or almost to zero without the stock moving only due to changes in implied volatility. It’s
very important that you understand this … It’s not rocket science. Go back to what I said. Implied volatility is the risk of future movement. It’s not that
People want to make it really complicated. It’s not. I think people who don’t understand it make it complicated. It’s really simple. If you want to
calculate it and do all kinds of other stuff it can get complicated. You don’t have to worry about that. You’re not going to do the calculations. We’ve got
all the tools for you.
Implied volatility as I said impacts the extrinsic value. Remember this chart. This is what happens before earnings. I introduced this concept, but I got a
nice little chart to show you. As earnings approaches you start seeing all extrinsic value getting bigger. Price of options getting bigger.
When does that commonly happen? Anybody? Before earnings. Before any event, right? It’s anything that has the potential to make the stock price move. I
wish that I could team up with somebody who knew pharmaceuticals. If there’s doctors out there, anybody that understands the drug market, there is some
[buku 00:35:46] money to be made on options out there.
Unfortunately I don’t understand the market well enough. I may understand how this works, but if I could partner up with a doctor or somebody we can make a
lot of money. Actually I’m doing pretty well on my own but big changes in implied volatility around FDA announcements.
Here’s earnings coming up, right? Then what happens after earnings? That my friend is called implied volatility, IV crash. Let me tell you my hot stove
story. Anybody ever touched a hot stove? You normally only do it once in your life, because you remember the next time. I put my elbow on a griddle when I
was a little kid. I was in the kitchen and I put my elbow up and fried that tender part of the skin right there next to your elbow. I still feel it today.
My hot stove incident with options was on Apple. The week before they announced the iPhone I knew something …
I love technology. I follow all technology. I listen to podcasts; I read stuff on the internet. You knew the rumors were out that Apple was … There was a
big announcement big Moscone Center. Apple’s got a big product announcement. This is going to be
I knew that Apple was going to introduce a phone. I bought Apple calls that were out of the money. Apple went up and I lost money. You bought calls, the
stock went up, you should make money. When I was a student and I didn’t fully understand what I was doing. I lost money on calls and the stock went up. The
stock went up you should make money.
If I bought the stock I would have made money. If I did some other trade, if I knew what the heck I was doing, there’s another strategy that I could have
used that would have made money. I know now, I know how to make money now, but then I didn’t realize. Just buying long calls. Anybody ever had that happen?
You go buy a long call and then the stock goes in your direction, but you lose money? It happens and that’s why I lost a significant amount of money. I
learnt my lesson there. That was my hot stove incident.
Understanding IV crash is an important concept. In fact, you can actually harness this and use it to your advantage. You can make money. Here’s a chart in
Netflix. This is from www.ivolatility.com. There’s a number of places to get charts like this.
We have two lines on here. You probably remember the purple line from before. That’s the historic volatility or the standard deviation. It says down here a
30-day HV … The gold line is an IV index. This is an index. Options have implied volatility. Stock does not have implied volatility. There’s no fluff on
the price of stock.
It is the price. It is what it is. There’s fluff on the price of options. There’s foam on the price of options. That’s where the implied volatility only
impacts the fluff. What I’m I plotting here? This is a calculation. This is an index that looks at a cross-section of options and does a calculation for
I’m going to introduce the terms that I’m going to talk about in a second. It’s getting towards the VIX and what’s the VIX is. I’ll explain what the VIX is
here in a second. What I wanted to show is you can see these very predictable patterns, a rise and a drop. 90 days later a rise up and a drop but then it
What do you think these are that happen four times a year? Anybody? Earnings. Everybody knows Netflix goes bonkers over earnings. There’s trades that we do
at OptionsANIMAL that you don’t have to worry.
Here’s the other cool thing; this purple line is the historic volatility. What normally happens to the historic volatility bar before options? When is it
the lowest before earnings? When is the volatility the lowest? Usually it’s before earnings. Folks, if are an economist, if you’re in the human behavior,
you can see it in this chart. You can see human behavior.
This is people buying insurance because they’re nervous. This thing can go nuts. It’s going to explode. It’s Netflix. It’s going to make a huge amount of …
I own shares, what do I do? Well a good thing to do might be to call a trade. Buy a put, sell a call. Put in call lock yourself in, neutralize volatility.
I’m not going to go into that. We can teach you that.
That action of people buying protection, call on trades, protective puts, protective calls, makes … This is human behavior right here. This is the market.
People buying options. I want to buy more options. What happens to the price of beanie babies when everyone wants to buy them?
The price of beanie babies goes up. Then when nobody cares about beanie babies anymore, the price of beanie babies goes down. That’s exactly what we see
happen here. After earnings nobody needs insurance anymore, so everybody sells their calls and their puts and the price goes down.
This purple line shows the volatility of the stock. What happens as earnings approaches and you own Netflix? Do you go buy a whole bunch of Netflix? Do you
go and sell a whole bunch of Netflix? No, because earnings is coming and you’re going to wait until after earnings to make your decision. We tend to see
the historic volatility mellow out … before, it’s human behavior.
That story makes sense. Doesn’t it? What would you do? Maybe you’d sell your stock, get me out of here this thing might go up $50. Wait a minute, I’m not
going to do that. I’m going to buy a put. If the thing goes up $50 I make money. I got to put protective on the down side.
That’s what people do. That’s what institutions do. That’s why this chart happens. You can make money. You can make money from this drop. You can make
money from this thing going up. You can make money from this. You just have to understand how to use options. It’s all there. You can be protected and
limit your risk the whole time. It is cool. I’m excited about that. That’s just how I am.
Let’s talk about the VIX. What’s the VIX? The VIX represents the implied volatility of a theoretical after the money option that expires in 30 days, got
that? The VIX represents the implied volatility. Implied volatility that’s the risk of future movements of a theoretical at the money option on the SPX.
If there was an option, the SPX trading at. What’s it trading act today? 15-something. If there was an option exactly at that price that expired in 30 days
and we can measure the implied volatility of it, that’s what the VIX is. Why do we do that? Because we need some sort of a benchmark. If you ever looked at
implied volatility per sense on a stock chart, they get a little confusing. When they’re out of their money some squally things happen. When they get close
to expirations some squally things happen.
If you understand the options you can process that but what they decided is let’s get something that just makes it easy for us to look and say, yeah. Is
implied volatility higher or lower? That’s why they came up with this calculation of the VIX.
Another way to think about it, do you remember those boxes that I drew those 30-day boxes? This is an Aha! for you folks. What the implied volatility as
represented by the VIX tries to do, is to predict what the historic volatility is. Remember I told you implied volatility is implying what the volatility
will be. That’s what the VIX does.
It tries to say what will the historic volatility be for the next 30 days? How do we measure that? How do we calculate that? The easiest way is to get into
a time machine and go forward 30 trading days. Yes, I’m being facetious or sarcastic, I’m not sure which. I’m making a joke. If you had a time machine and
you could go forward 30 days, then look at the VIX over the past 30 days and do a calculation on the historic volatility, that’s what the VIX tries to do.
I showed you that chart on Netflix, that gold mine that came from www.ivolatility.com.
Trade Monster actually has a pretty good one too and there’s other places out there that have those charts and they’re VIX like calculations. As a matter
of fact, the CBOE now has introduced five volatility indexes on different equities. There’s one in Apple, there’s one in Goldman, there’s one on Amazon.
There’s five of them that are now out there. That are stocks in those that you can get. I think VX APL is the VIX Apple that’s out there. It’s basically
the same sort of calculation. It does what I said. It tries to look forward 30 days and say, “What would the historic be in 30 days?”
Calculating the VIX isn’t that easy. How do we find the implied volatility of an option? I’m changing gears here. This is what a lot of people think; we
know how to calculate the implied volatility of an option. You’ve got the stock price, the strike time, the expiration dividends, free interest rate,
implied volatility. All of those things go into a formula. Anybody know the formula? The Black-Scholes model. These guys won the Nobel prize in Economics,
Fisher Black, Myron Scholes. Those guys know how to party. They are awesome. Just kidding. They’re legends.
Actually, Myron Scholes is still a professor at the University of Chicago and these guys are geniuses. Of course, they are also the geniuses that went on
to form long term capital management. Another example of why academics don’t actually know how to trade very well.
The theory works great. This is how we solve for implied volatility. When you look at implied volatility percent when you go to an options chain and you
say, “What’s the implied volatility on that?” You can look on the chart and say, “Yeah, it’s got a number.” That’s how it’s calculated. It uses something
like this model.
There’s a couple of tweaks on this model. There’s the Martin version and then there’s the Berkshire Scotland’s model. Mathematicians you guys can geek out
on that, real people don’t worry about it. The numbers are there for you. You just got to understand. Guess what, that’s not how we calculate the VIX. We
don’t calculate the VIX that way.
The way we calculate the VIX was created by Dr. Whaley from Duke University, so picture of Dr. Whaley there when he was at Duke. He’s actually at the
University of Virginia now. He tried to create this thing back in ’93 to be a benchmark of short term volatility, so that we can eventually be able to
trade against it.
Like I said it’s a forward looking measure and you can get that. This is straight out of his paper. You can Google the paper, you can find it on CBOE.
Interesting aside here as I saw at Dr. Whaley interviewed on CNBC by Simon Hobbs.
Simon was interviewing Dr. Whaley and said, “Congratulations on creating this thing the VIX that’s talked about so much and it’s so widely used. You must
have done very well for yourself.” Dr. Whaley says, “Actually, I didn’t retain any of the rights. I gave it all to the CBOE.” He’s not making any money out
of his awesome … Another example of academics who aint so good at business.
How do you calculate the VIX? I’m going to go through this really quick because this is a bit of job. You use two months of options, which two months do
you use if there’s eight days or more, we use the current month and then the next month. We don’t use the weeklies. This month there’s expirations March 15 th we’re going to use March and April options. If there is less than eight days we would, when it comes to less than eight days, we’re going to
use April and May options. Right now we’re using March and April options.
We use all of the out of the money options that have none-zero bid prices. We determine the forward price which is by taking the absolute difference
between the bid of the call and the bid of put and determine where the difference is the lowest. That’s what we call the forward price. We calculate
exactly how many minutes the expiration then we do a whole bunch of math. Then we take the square root, multiply our 100 and that’s how you get the VIX.
Why do I go into this? Because the VIX is complex. Why go over that? Because it’s complex. There’s lots of different moving parts on there, all kinds of
things that can impact you and maybe go wrong. That was a little bit of a joke, but that’s true.
The VIX is a pretty complex thing and pretty quirky thing. Anything that’s that complex has some weirdness to it. Take for example, rolling from one month
to the next month when there’s eight days left. Do you think that impacts the price of the VIX? Yes. Do you think it has anything to do with changes and
implied volatility? No.
The VIX changes but it doesn’t mean there’s a change in implied volatility. The forward price, that’s impacted by the pricing of options using only out of
the money. Why do they do that? I don’t know. They could use any of the money options too but they only use out of the money. They only use the ones that
have none-zero bids. That’s weird so they might skip a few.
All of these factors that we’re talking about here can be impacted by implied volatility, I agree. That’s what we’re trying to measure by implied
volatility but guess what the market maker he has control of the bid/ask spread so he can impact the VIX.
If somebody placed a large trade at a specific strike, they can actually move one of these things that I talked about that are going into the calculation.
Yes, you can move the VIX by placing the specific trade even small traders.
Folks, you with $50 can move the VIX. It looks good on you resume, doesn’t it? “I moved the VIX. Look at me.” If you want to waste $50 you can make the VIX
move. I got an Excel spreadsheet that shows how the VIX is calculated. With $1,000 you can actually make a pretty significant move in the VIX if you wanted
to move the VIX. Why would you?
You can’t trade the VIX. We’ll get there. It’s quirky. Traders can impact the VIX. It’s weird. There are some other quirks too. We have a quirk called the
calendar quirk towards the end of the year, December tends to have more holidays but the calculation doesn’t take that into account. It artificially makes
volatility look lower than it is because there’s the same amount of volatility is spread over the last days.
We also have the skew. Sometimes when the market moves down people will buy more puts. That makes the VIX go up. It may and it overstates the fear that
News. Good news happens, right? Remember I talked about implied volatility. Implied volatility could be good. There could be something good that’s coming
out and that could make the price of options. Everybody wants to buy calls because something good is going to happen.
That can cause the price of the VIX to go up but people say it’s fear. It’s not fear. You got to be careful with the VIX. It’s got a lot of quirk out
there. What does it measure again? It’s the implied volatility of the theoretical at the money that expires in 30 days.
What it tries to do is predict the historic volatility. How well does it do that? I’m a mathematician. I’m not a mathematician. I’m actually an engineer
but I don’t take anything for granted. I study everything. Here’s a comparison of the historic volatility and the implied volatility.
What I noticed on this is that there’s not a lot of lag that they tend to move together. Let’s just focus on what this means. How well does the 30-day
historic volatility compare to the VIX. That’s what the VIX is trying to do. Is telling me what the historic volatility is in 30 days.
The R squared, this can be expressed as a percent. 59% co-relation, 59.7%, 60% co-related. It’s somewhat co-related. I would say 60%. That doesn’t make me
feel great. It’s more co-related than not. That’s 30 days from now. That’s the volatility of 30 days from now. I did this math myself and I said, “What if
I did 20 days, 21 days? I looked at all different sorts of days.
What really struck to me was that historic volatility today has the best co-relation to the VIX. That’s not supposed to be what happens. You’ve got an 81%
co-relation to today’s historic volatility. That means that the VIX which is supposed to predict implied volatility or historic volatility in 30 days from
now is more related to what happens today.
What does the VIX really tell us? That’s what it tells us. It’s what the historic volatility is. It’s a complicated way to measure what we already know and
can calculate a lot easier. Just take the standard deviation. You don’t need to go through all that mess.
What does it tell us? It does give us some indication of fear but usually is that fear because of what’s going to happen or because of what did happen? The
market moved and people … What moves the VIX other than those quirks, but what really moves the VIX is people buying options. People going out and buying
options on the SPX.
Why do we do that? You may own a dozen different stocks; if you want to hedge your whole portfolio you go by puts or calls or do whatever you do. You do it
on some index that represents your portfolio rather than, I’m going to buy options on Apple, I’m going to buy options of GE, I’m going to buy options of
Lulu Lemon. It’s just easier to go hedge your whole portfolio on the VIX or in the SPX. That’s why we do the VIX. What the VIX really tells us is whether
options are expensive. It gives us an idea of option prices. Are they expensive or not? When the VIX is high options are expensive. That’s what it tells
Not a very good predictor of future volatility though. It isn’t. Honestly the VIX doesn’t do what it’s supposed to be. I listen to the people on CNBC
everyday talking about why the VIX moved today. A lot of times it moves because it’s quirks, it’s almost a ‘So what? Who cares?’ The VIX is really
A lot of people want to try trading the VIX. Let me ask you guys some questions. Can you trade the VIX? Yes or no? Can you trade the VIX? The answer is no.
You cannot trade the VIX. The reason why is because … I’m talking about the spot VIX, the VIX that we look at today. You cannot trade the spot VIX.
The reason why is what I talked about manipulation. I personally with $50 can move the VIX. With $1,000 I can really move the VIX. Why would why? If I had
a lot of money and I could trade the VIX, I would put $1,000 in the VIX and then I’d put $100,000 in some other trade that takes advantage of it.
“No, Nobody would ever do that Eric. Nobody would ever manipulate the market to be in their favor. Come on, common sense, no.” Yes, absolutely. That’s why
you can’t trade the VIX. It can be manipulated. It’s not a joke. Its complete fact and I can show you. Can you trade options on the VIX? No, you can’t
trade options on the VIX.
“Eric, I can go looking at options here and I see options.” Those are options on VIX futures, which is a completely different thing. Those are options on
VIX futures. The VXX and some of these others are based on VIX futures. Those are actually some combination of VIX futures usually.
If you’re going to trade options on the VIX futures you better know how to get information on the VIX futures. Can you trade VIX futures? Now you’re afraid
to answer me probably, right? The answer is most of you cannot trade VIX futures. You need a special account. There’s only a few brokers out there but if a
retail trader really wanted to trade VIX futures they could.
Most of you if you’re listening to me right now can’t trade. You have the ability to go find an account with a specific broker. Most brokers that most of
you have accounts with do not offer VIX futures. I know some of you, “My broker offers.” You can trade VIX futures.
Let’s talk about that manipulation thing. As I mentioned the options on the spot VIX are not traded because it’s easily manipulated. The VIX is derived
from the out of the money options because I can place trades on the out of the money options, I can manipulate the VIX. Futures on the VIX are set by the
Mostly those are done by institutional traders, people hedging their portfolios or organization, entities hedging their portfolios. The question I ask is
for those of you that are trading the VIX if you’re not with me step on this then you definitely shouldn’t be trading the VIX.
The question I have is, are the VIX futures impacted by SPX options? Let’s go, follow me on this logic. The VIX is calculated based on SPX out of the money
options. If that’s true then it’s logical to conclude that the VIX futures are co-related to the corresponding SPX options and this is a fact.
Institutional traders will take the out of the money options on the SPX and put them into a model and calculate what the VIX is implied to be in the future
and then compare that to the actual future. If what I just said to you is making your head hurt you absolutely better not be trading the VIX futures
because that’s what the professionals are doing.
If you don’t know how to do that calculation, you have no right trading the VIX futures. That’s what institutionals do, and because of this fact VIX
futures can be manipulated too. Personally I traded VIX futures for about four months. I thought I had a trade down that were great.
At the end of the fourth month I ended up taking it pretty hard. I really couldn’t understand what happened and I think I got manipulated. This is not a
place for retail traders to be trading. Let me give you an example. This is a trade that I see people still promoting. Let me give you an example.
Here’s a trade that would have been placed on September 8th the VIX is trading at $23.06 here’s a chart of the VIX. If you’re smart, if you’re
going to trade anything on the VIX, I don’t care if it’s the VXX or anything else. You need to be able to plot the VIX’s futures. The VIX looks stagnant
and if I look at the VIX futures, those are even more stagnant so here’s the two chains or the two charts for the VIX futures. Some look stagnant. What’s a
good trade to do when it’s stagnant? A good trade might be an NR condo, a calendar trade would work very well in the stagnant trend.
Let’s say that we do a call calendar. I buy the open the December 25 strike for $2 debit and I will sell to open the October 25 strike for a $1.50 credit.
What’s the net debit on this trade? Anybody trade calendars out there? What’s the max risk on our VIX calendar trade? The debit, you think so, 50cents.
Does this look like a safe trade? Is it worth doing for 50 bucks? Not $50, two-10 contracts, right? What’s the most you can lose, $500? Do 10 contracts,
right? What’s the most you can lose? 500 bucks? Do 10 contracts. It’s only 500 bucks. It looks stagnant. No big deal, right?
People did this trade. Come October expiration what happens to the VIX? There’s a big movement. The December 25 which I bought for $2 is now worth $13.50,
awesome. Except the October which I sold for $1.50 is now worth $38.35, meaning a loss of $25.70. If I did 10 contracts on this, I just lost $25,700.
This happened to people. There are people out there recommending calendars on the VIX. I just saw a webinar just a couple of weeks ago of some professional
company telling you to go do calendars on the VIX. I’ll yell till I’m blue in the face. People go, “No, the most you can lose is the debit on a calendar.”
These are not standard options. This is like doing a calendar on … let’s say you bought a call on Coke and sold the call in Pepsi. That’s what that’s like.
Usually those two move together, not a big deal. Might be okay. The VIX is a completely different beast and because of that you can take huge losses.
I do not advocate trading the VIX, unless if you can run those models that I talked about or any of the exotic exchange traded notes. I’ll bet you that
anybody who’s trading those is not making money. Anybody listening to this is not making money. At least not making enough money to pay for an electricity
bill for three months.
You’re making more than enough money to pay for an electricity bill for three months, it’s not luck, and you know what you’re doing, congratulations. Most
of the people who trade the VIX lose money.
Conclusion here is that historic volatility looks backwards, implied volatility is looking forward. That’s an awesome crystal ball. Don’t get me wrong
about trading volatility. I trade volatility all the time. I just don’t trade the VIX. That curve I just showed you going up and down around earnings, Greg
will tell you, I love that thing. I make money. My risk is so low it’s not worth it to try and mess with those exotics.
Implied volatility can be managed and it can be traded that’s an edge that you can have. You’ve got to be really careful if you’re going to try and do
anything with the VIX. You can make money with the stuff, and we can show you how.
Greg: Let me interject here, Eric, thank you. One of the things, like I said I do a lot of these webinars and I will say that of the questions that were
asked by you in the class. This is by far the most times I’ve been asked. I usually get asked this question in every single webinar we do is, is this
webinar recorded and can I watch it later. I was asked that more times in this webinar than any webinar I’ve ever done before. We just went over a lot of
Eric: People’s heads are exploding?
Greg: I hope you all realize this is really important stuff. One of the things that’s really unique with OptionsANIMAL is how we teach. Absolutely we
record our webinars and we make them archived for all of our students. We don’t just give you, here’s a big [Rarar 0:65:14] seminar we’re all going to go
to and come and learn how to trade.
We teach like this primarily. We teach in a webinar format where you can come in and participate. You can come in and ask questions, you can come in and
learn at your own pace. If this is way over your head, we archive it and record it and you go and watch it again and again. You can watch it from a
Maybe you didn’t like the way Eric taught the presentation because it was way too deep. We have multitude of different instructors who do the same thing
all of them experts in trading. They are all academics to their certain degree. The one commonality we all have is we’re all trading, we’re all making
money. Let me just give you an example.
One of the things we do as an organization we send another thing called an Animal Trade. We’re very systematic in how we trade. I just wanted to show you
our real results. These trades are placed by our instructors. They’re updated real time, so that our students can follow along with them. The results of
these trades and Eric you’re going to have to click through the next slide because you still have control of the screen.
We’ve sent out 145 of these trades. The average duration in the trade is 48 days. We have 11 of them open. 9 of them closed for loss, 125 of them closed
for profit. That’s not because we have a crystal ball and we know exactly where stock is going, or where the SPX is going. It’s because we know how to
adjust trades that have gone the wrong way and that’s one of the specialties we teach people at OptionsANIMAL.
The average return per trade is about 8% and that doesn’t include the losses those 9 losses as well. If you annualize that, it’s about a 60% annual return.
Our win loss ratio 125 out of 134 is about 93%. We do end up having to adjust a handful of those. 45 of those trades were adjusted. About 30% or about a
third of every trade we look at ends up having to be adjusted.
This can be learned folks. We teach it better than anyone in the market. Not just with our expertise and the people we have teaching the classes, but the
way we teach you, so that you can take it over and over again and have the ability to interact and get your questions answered.
This is all included in the course or the curriculum. One of the things we’ll do right now is special offer for you folks in this webinar. If you want to
lock-in in pricing for some discounted price we’re offering right now. Give us a phone call within the next 30 minutes to find out how we can help you.
Hopefully what you’ve seen with what Eric has just presented is that there’s a whole depth of information that you as a trader need to learn before you
venture out into the market.
One of the things I have found in my tens of thousands trades that I’ve executed is the market doesn’t care whether you think you get it or not. It just is
the market and it will teach you some very painful lessons. That’s what we’re all about at OptionsANIMAL. Is teaching you how to succeed in the market,
showing you how to succeed in the market by allowing you to look over our shoulders and being part of a great community.
Again if you want to lock in a 25% discount on the retail price, give us a phone call in the next 30 minutes. The phone number is 888-297-9165. For those
of you who happen to be calling internationally and 800 numbers don’t work, 801-331-7500.
Eric, thank you for coming. I thank every one of you for taking the time out of your day for coming today. Again, give us a phone call here and speak with
one of our experts here on the phone. We can get an idea of how we can help you custom fit a program that will help you become a better trader and how to
use implied volatility to help improve your results.
Thanks again for coming and I look forward to seeing you in class.