"Skinny" Spotlight: Options Modeling
Sep 1, 2015
The "Skinny" series on the tastytrade network is a platform for breaking down a variety of options trading concepts into more easily digestible building blocks.
Specifically, "Skinny" episodes typically feature experts in math, data, and modeling that share their experience with tastytrade viewers to help provide background and reinforcement on many of the more complex trading-related subjects that are often featured in tastytrade programming.
In the past, the blog has highlighted episodes from the The Skinny on Options Math and The Skinny on Options Data Science and today we complete the circle by introducing The Skinny on Options Modeling!
The Skinny on Options Modeling typically features Tom "TP" Preston, a frequent contributor and quantitative strategist on the tastytrade network. However, Dr. Data (Mike Rechenthin) has also been known to take a seat at the options modeling table.
Today on the blog we are in fact putting the spotlight on one of Dr. Data's recent options modeling appearances because the subject dovetails very well with some other fresh content on the network and blog.
Entitled "Selling IV Where It Counts," Dr. Data joins Tom Preston and Tony Battista with some critical things to consider when dealing with high implied volatility as it relates to options trading decisions.
Dr. Data kicks off the episode by reminding viewers that when all else is equal, higher implied volatility generally translates to higher options prices, which means we can collect more premium when we sell options.
However, Dr. Data qualifies the above statement by saying that each and every instance of high implied volatility doesn't necessarily equate to an optimal trading opportunity.
As a reminder, Dr. Data reminds viewers that implied volatility is simply the option's price relayed in different terms, as shown below:
Dr. Data goes on to explain that vega, which is the measure of how much an option’s price changes given a 1% change in implied volatility, decreases over time. In simpler terms, this means that as an option gets closer to expiration, it takes a much more pronounced move in implied volatility to meaningfully impact an option's price.
This phenomenon is depicted in the graph below:
Breaking the above down even further, we can say that options with only a few days until expiration may have a very high implied volatility, but ultimately a very low price in dollar terms.
What this means is that as an option gets closer to expiration, implied volatility becomes less valuable as an input in trading decisions. Dr. Data goes on to detail how implied volatility can actually be deceiving when days-to-expiration (DTE) dips to three or less, as illustrated in the slide below:
Dr. Data concludes the episode by indicating the implied volatility measurements in options with 30-60 days-to-expiration should more accurately reflect their true premium and could therefore be more useful as a factor in trading decisions.
The entire episode on high implied volatility can be found by following this link.
Additionally, we encourage you to delve deeper into the tastytrade library of content on implied volatility by following this link.
We greatly value your feedback and would appreciate any comments or suggestions on future tastytrade programming in the "comments" section below.
Additionally, we encourage you to get in touch on Twitter or email at @tastytrade or at firstname.lastname@example.org.
Thanks for being the most important part of the tastytrade community!
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastytrade is a trademark/servicemark owned by tastytrade.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”).
tastyworks, Inc. (“tastyworks”) has entered into a Marketing Agreement with tastytrade (“Marketing Agent”) whereby tastyworks pays compensation to Marketing Agent to recommend tastyworks’ brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastyworks. tastytrade is the parent company of tastyworks. tastyworks and Marketing Agent are separate entities with their own products and services. tastytrade has different privacy policies than tastyworks.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.