Finding Value for Options Trades Amongst the Sea of Choices: Stocks, Crude Oil and Gold

In a recent article I discussed one of the essential elements of finding value when trading options: liquidity. Finding markets with good liquidity are not so easy to find. Just because an option has a bid and offer one cent, tic, or minimum fluctuation wide, that doesn’t mean it is liquid. If the value of the option is 33 cents and the bid/ask spread is one cent, you have a 3% wide spread. By the time you get finished with buying and selling the option, plus commissions, the costs of trading the instrument are quite steep. In the long run, traders giving up this kind of edge are not going to make money.

Now that I have beaten the liquidity thing to death, what should traders of Stocks, Crude Oil, Gold and other instruments look for when establishing positions? The key component beyond liquidity is analyzing the Implied and Historical Volatility and the Implied Volatility Skew. These factors enable traders to make intelligent choices about price, and design Options Trading Strategies which meet their investment goals. A simple example comes from Wednesday evening’s set of prices for the E-mini S&P. Using the first Value Evaluation Table below; you can make the following assessment: the E-mini’s Implied Volatility is trading at a premium to its 20-Day Historical Volatility. It has a Relative Strength Index of about 60, which is not indicative of either an overbought or oversold situation.  The Implied Volatility of the out-of-the money Puts is substantially greater than that of the Call. In addition, the Liquidity of the Put as measured by the Bid/Ask Spread is, although taken at night, approximately 3.5%. The width of this spread under normal circumstances may cause concern, however this will probably tighten up during the day session.  All of this information, particularly the pricing pattern, provides the opportunity to create Options Trading Strategies which meet your risk/reward requirements. By analyzing the Implied Volatility in the E-minis, one can create a Long or Short Strategy which meets your directional bias, with good value, rather easily.

The Snapshot of Gold Options finds a different Implied Volatility Skew than the one in the E-minis. The Calls are priced with a higher Implied Volatility than the Puts. This type of pricing requires traders to use different trading strategies than those they might have used in the E-minis. Although the liquidity and Relative Strength Index are approximately the same, understanding the difference in pricing structure is essential for getting good value in your transactions. At Options Strategy Network our goal is to help Individuals and Corporations design positions that meet their risk/reward requirements by enabling them to build appropriate positions through the analysis of liquidity, historical and implied volatility, the skew and the best options strategy to meet their goals. Contact us  to structure a program that meets your individual or corporate requirements.

Whether you are trading Stocks or Stock Index Futures, Gold or Crude Oil, the goal is to have an analytical strategy which enables you to dissect the essential characteristics of any trade and decide if you are getting good value. If you are an effective directional trader, using charts and fundamental analysis, either leveraging yourself through options or mitigating risk can provide a new dimension to your trading. Just as adding bunting to a pitcher’s game can add an extra victory over the course of the season; evaluating liquidity and the implications of the Implied Volatility Skew can add extra profit to your bottom line. Contact us  to see how we can help you build more profitable strategies. Our thirty years of trading and risk management experience can be an excellent addition to your skills.

OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. THE INFORMATION IS OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, BUT IS IN NO WAY GUARANTEED. PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS.

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