Volatility is often referred to as the “fear index.” With the VIX trimming its waistline (along with Tom), one could say fear is non-existent in equity markets. Or perhaps a more accurate statement would be investors have become complacent. Regardless of how you phrase it, as Dylan humbly pointed out, no volatility = no premium selling opportunities.
Or does it?
Our core business as tastytraders is selling premium during times of elevated volatility. Therefore, Dylan posed the question to Tom: “if you sell volatility when it is elevated, do you buy it when it is low?” Tom’s answer... maybe.
Buying and holding volatility, or ‘inventorying’ volatility as we call it, is difficult. Tom walked Dylan through volatility contango, which occurs when future volatility is more expensive than present and explains why that makes holding long volatility too costly most of the time. However, sometimes, especially in times like these, the potential payoff is too great to pass and even Tom will take a measured shot.
Unlike the fireworks of last time, Tom agreed with Dylan that this is not a market with many opportunities. But there is a level of comfort knowing this cannot last forever. Volatility is mean reverting. It will rebound. And when it does, tastytraders will sell it. Tom likened it to the housing market.
During strong markets, we buy second homes, rent them out and lower cost basis on those homes. Airbnb is one of the hottest ideas around because you can rent out a second home or even an empty room in your primary residence to reduce cost basis. We do the financial version of this at tastytrade. For some reason, a gap exists between understanding that reducing cost basis in stocks is no different than renting out a room or home. But hey, if that gap did not exist, then right now we really would have nothing to do.
Josh Fabian has been trading futures and derivatives for more than 25 years.
For more on this topic see: Truth or Skepticism: Volatility Will Rise Again - April 14, 2016