The importance of having a balanced portfolio of option credit spreads

After what seemed like a never ending upward trajectory for stocks (well, ok mostly tech stocks) , we finally had some volatility in the markets over the last few weeks. It’s interesting that when the market goes up fast the VIX falls (isn’t that also increased volatility?) I guess that’s why it’s more aptly labeled the Fear Index. For credit spread traders, for a while it was 1) difficult to find opportunities as the VIX fell to the low 20s (see below). Hello? there is a pandemic going on! As a refresher, low volatility = lower option prices = lower premium on option spreads, and 2) it was difficult to implement any bearish call spreads at the risk of soon being forced to close for a loss. This is why you want to give more distance between your short strikes and the current market price during these times. The problem was there wasn’t much premium to be had.

I always stress the importance of not being overly overweight in either bullish or bearish spreads. Long-term success in this game is riding both sides of the market. When markets either race upwards or fall fast (both of which we’ve had recently) we want to have exposure for either situation. Having all your eggs in one basket can result in a bunch of scrambled eggs. When the market is roaring higher, the feeling is to jump on the bandwagon and load up on put spreads. Remember, though, we generally have expirations of roughly 30 days out so the present is no predictor of the future. The tech sector has taken it on the chin over the last week or so, so there you go.

With an election coming up soon, all bets are off on what is going to happen. Normally, a democrat in the white house is seen as a negative for the market. However, this time around it could be viewed as a more stable situation. Who knows? The fact is, the next 30 days could be a rollercoaster as one poll after another comes out. This should result in higher volatility and, correspondingly, more opportunities to trade credit spreads. It may be time reap the crop!

Good luck in your trading!

Joe Simmons, CFA

http://creditspreadtrading.com