04/08/2021 — The Dregs

The market continues to rise and volatility continues to fall — somewhat. Although the relationship between market direction and volatility trends inversely, there’s obviously a limit to this. Stocks can rise forever, at whatever speed, but vol can never drop below zero, and its movement will slow tremendously as it starts to approach nil.

At all-time S&P index highs, the VIX sits muddling around 17. After a year filled with much market turmoil, this feels like an incredibly depressed level, but a quick look at the historical value for the S&P index shows that 17 lies right in the average range — the high teens. Over its existence the bellwether has dipped into the 9’s, so it might seem that trading options in average volatility wouldn’t be such a bad thing.

The problem with the current lack of more substantial volatility is that it doesn’t match current market conditions. Stimulus bills and pandemic reprieve may be pushing, or perhaps propping, the current bull rally, but circumstances are not at all normal. One false head-fake, a couple bad indicators, or even just a short squeeze could send stocks reeling and volatility jumping. From a trading standpoint this makes every move precarious.

Selling options outright carries danger, as any faint move downward could send option prices soaring, that’s not even taking into account a real panic, like if bond yields unexpectedly eye higher levels as the US government continues to print money. Buying options isn’t all that much better…if nothing changes, a trader with a long position can slowly watch his holdings bleed out if volatility sinks into the lower teens. Neither of these possibilities are unlikely considering the current state of the world.

Therefore, I’ve found myself left with the mediocre strategy of legging into long put spreads. Keeping a keen lookout for straggling put bids to sell for literal nickels and dimes isn’t only boring, it isn’t all that profitable, and exposes me to downside risk while I wait for time to do its work on the option series. To complete the spread, I’m forced to hold the naked position until someone offers the same price on a put a couple hundred points closer to the money. That takes a day…or four. Without the possibility of volatility suddenly dropping (it doesn’t often drop rapidly from average levels), I’m at the mercy of time, and my instincts.

It’s the dregs.