Mean reversion is very important to what we do at tastytrade. As mean reversion traders, we look to exploit price extremes and volatility because we believe they will revert to their mean over time. Volatility proves to be the one variable that is recognized as being ‘mean reverting’ in many option-pricing models.
It is important to know the difference between price extremes due to binary events and price action. We tend to disregard binary events when we look for price extremes because they are somewhat expected (a great example of this is an earnings announcement).
Mean reversion and market cyclicality is one reason why we roll losing trades as opposed to closing them. As long as we assume the market is cyclical, we have found that we can roll perpetually until we are right. However, the moment our assumption changes, we may consider closing the trade.
Since IV has proven to be mean reverting, we base our strategies around that factor primarily. In low IV environments, we trade debit spreads and in high IV environments, we trade credit spreads. Buying into weakness and selling into strength make us contrarians. Combining this mindset with correct strategies in relation to IV, will help us develop a winning strategy in the long run.
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