Tom Preston Proved Live That Most Traders Are Choosing the Wrong Expiration on High IV Stocks

SPACEX

In a high implied volatility environment, selling a short vertical spread on a stock like SpaceX can be a profitable strategy. The initial premium collected is substantial, and as time to expiration increases, the premium collected continues to increase, albeit at a diminishing rate. This strategy is suitable for traders who are bullish on the stock and are willing to take on the risk of a potential loss if the stock drops below the short put strike price.

Micron

The speaker suggests selling a put spread on Micron with a 3-day expiration, leveraging the high implied volatility. The trade aims to collect a $40 credit, which is higher than the potential $115 or $120 reward from a longer-term option. The trade is based on the expectation that the underlying will remain within the strike range, allowing the seller to keep the premium. However, the high volatility may lead to increased risk if the underlying moves significantly.

SpaceX

In a high IV environment, short put spreads can be effective as the volatility rewards the short position. The strategy is suitable for bullish market conditions, where the underlying asset is expected to trade within a range.

High Implied Volatility and Option Pricing

High implied volatility (IV) in stocks like SpaceX and Micron leads to higher premium collection when selling options. As time to expiration increases, the premium collected from short vertical spreads increases initially but at a diminishing rate. This is due to the nature of option pricing, where the premium is influenced by both time decay and volatility. Even though volatility decreases over time, the initial premium collected from short-term options can be substantial, and extending the time to expiration may not significantly increase the premium collected.

High Implied Volatility and Short-Term Options

Trading short-term options in high implied volatility (IV) environments can yield higher credit premiums compared to longer-term options. The speaker explains that the credit collected from selling spreads increases as the time to expiration increases, but this is influenced by the volatility of the underlying asset. Short-term options with high IV can offer more immediate rewards, though the trade-off is the limited time horizon.

Impact of Volatility and Time on Options Pricing

An increase in volatility and an increase in time both have the same impact on an options price by increasing the extrinsic value. Volatility is described as synthetic time, and time is synthetic volatility. High front-month volatility can significantly reward short vertical strategies, while the impact of time diminishes as volatility remains high. In contrast, lower volatility products benefit from extending the time of the vertical to collect more credit and improve the risk-reward ratio.

Why is the implied volatility of SpaceX higher than the VIX?

The implied volatility of SpaceX is higher than the VIX because it reflects the market's expectation of large price swings for a relatively new and uncertain company. The VIX, on the other hand, measures the volatility of the S&P 500, which is a broader market index with more stable price movements.

TakeawayHigh implied volatility in stocks like SpaceX indicates significant market uncertainty and potential for large price swings, which can be exploited through options strategies.

What is the advantage of trading shorter-term options in high implied volatility?

Shorter-term options in high implied volatility environments can offer higher credit premiums due to the increased volatility. The speaker explains that the credit collected from selling spreads increases as the time to expiration increases, but this is influenced by the volatility of the underlying asset.

TakeawayTraders should consider the time horizon and volatility when selecting options strategies, as high volatility can lead to higher premiums in shorter-term options.

How does time affect the price of an options vertical?

Adding time to a short vertical increases the credit received, as time is synthetic volatility. The extrinsic value of the options increases with time, but the impact is less significant when volatility is already high.

TakeawayTime adds value to short verticals, but its impact is moderated by volatility levels.