Getting an Edge with Options

10/04/2013 8:00 am EST

Focus: OPTIONS

Mark Sebastian

Founder, OptionPit.com

One of the questions he gets most is “How do I find edge in the marketplace?,” says Mark Sebastian of OptionPit.com.

There are thousands of ways to do find an edge, and many of them take years of training and trading to learn. There are also ones that are much simpler than they may seem. One way of capturing edge, that Andrew and I like is buying options in stocks that have vols that are at multi-year lows, especially when they are high flying stocks.

One clear example was Apple (AAPL) last year. Right before the stock ripped from the high 500's to the 700's, the IV on calls was at an all-time low.

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Livevol® www.livevol.com
Click to Enlarge

In fact, in this case, just about every dip below 22% is a huge option premium buying opportunity. Many of them pay off in less than a week. More recently, Priceline (PCLN) saw its vol get completely crushed as it approached 1000.00. Traders were selling covered calls, selling puts. It was an all-out vol crush:

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Livevol® www.livevol.com
Click to Enlarge

Like AAPL before it, PCLN broke through the call sales at 1000 and the stock has taken off, moving more than 100.00 in about a week. Considering that one could have bought the Oct 960 straddle for around 60.00 dollars a few weeks ago, this is a CLEAR win for premium buyers.

How to Capture Edge
The key to this approach is not simply to find stocks at all-time low vols, there might be good reason for that (see NTAP). Find stocks that have a history of moving, that are at or near recent highs, and have IV's that are at their lowest levels of the year, and preferably in years. This strategy, we think captures edge. If one buys enough spreads gamma scalping might be needed while the trader waits. In the end though, vol is just like a stock, when it’s oversold, it’s almost always a buy.

Obviously, this is not the only part of trading, but there are those that think there is no edge in buying options, the above simply points out that this is untrue. There is plenty of money to be made buying premium.

By Mark Sebastian, Blogger and Contributor, OptionPit.com

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