Articles

The dream of any option trader is to buy some cheapie call or put option and have the stock or index go massively in the money and walk off a hero.

In all my years trading options, this has only happened to me once.

In November 2019, I observed that implied volatility in the S&P 500 Index (SPX) was very low, as there was a lot of complacency in the markets, so I put on a portfolio hedge. I bought some 80% strike SPX puts with a January 2021 expiration. They were incredibly cheap. By the way, an 80% strike means down 20% from current levels.

Well, you know what happened next. We got hit with the pandemic, and the market crashed 35%. Now, the thing with options is that you have to monetize them because the stock or index has a nasty habit of going in the other direction, with you owning an option that expires worthless. So, I sold those puts—at about 30X what I paid for them. A true hero trade, and good timing on the way out.

Well, I tried the same thing in January 2022. If you recall, the market was very bubbly, so I thought I would buy some puts. And I did, about a year out. As you know, the stock market was down about 20% that year. But I only made 2X on my puts. Why? Because I didn’t buy cheap options—implied volatility was already high, and they were very expensive.

How Do You Know?

How do you know when options are cheap or expensive? I talk a little bit about that in the Options Masterclass (available now!), and I basically say that a lot of the time, it doesn’t matter. You can buy expensive options and make money, and you can sell cheap options and make money. But it is a good idea to have some sense of richness/cheapness of options. You can eyeball it—80 vol looks a bit high, but it is better if you know where implied volatility is compared with realized volatility. 

Unfortunately, the only place I know to get realized volatility numbers is Bloomberg, which is expensive. But again, most of the time, it doesn’t matter—I trade options all over the place and rarely look at this, but I have been burned a few times.

Like most things in markets, it comes down to supply and demand. When there is demand for options, the price rises. When is there demand for options? When a stock is about to report earnings. 

I’m sure you’ve been watching CNBC one day and saw something about how options are pricing in an 8% move for XYZ stock. What they’re looking at is the price of the at-the-money straddle and reverse-engineering what magnitude move is expected for the stock.

Sometimes, options are just obviously overpriced. I once vultured up some money selling short-dated call options on AMC during the meme-stock craze. In my novel All the Evil of This World, I talk about a situation in which options were very overpriced. Again, I can’t really teach this—it just takes experience from a lifetime of staring at the screens.

I worked with an old options trader at Lehman Brothers. He used to make markets in Microsoft options. One time, a sales trader yelled over to him with an order to sell a few thousand Microsoft puts. He looked at the screen and said, “Zero interest.” He looked at the screen and said, “Less than zero interest.” He looked at the screen and said, “I’m a seller.” 

It was fascinating to watch his thought process in real time. He wasn’t doing any quantum physics about realized and implied volatility. He just knew by gut feel that those options were too expensive, and he didn’t want to buy them.

That’s the point I want you to get to. But you have to practice.

The Course

This is my pitch for the Options Masterclass:

1. It’s for everyone, at all experience levels.

2. It’s better than all the books out there, which are either too high-level or too low-level.

3. It’s in my writing style, which you like.

4. There are stories and examples.

5. There are copious charts and graphs.

6. There are mathematical concepts, but there is no math.

There is an old saying about how it takes a genius to explain a complicated subject so that anyone can understand it. For example, in the Natenberg book, there was this complicated equation that you had to memorize to determine the value of a forward. I spent months memorizing that formula. 

In my Options Masterclass, I explain it in a paragraph, in such a way that you will never forget it. Making complicated concepts simple. That’s the point of this course.

I wish I had something like this when I was starting out.

Jared Dillian, MFA