Actionable insights on equities, fixed-income, macros and personal finance Start 14-Days Free Trial
Actionable investing insights Get Free Trial
CM Strategy

Optionalysis: Writing Options Fraught With IV Rise Danger, But Risk/Reward Favourable

Optionalysis: Writing Options Fraught With IV Rise Danger, But Risk/Reward Favourable

This is a post for Capital Mind Premium subscribers, sent on 02 May 2014.

You might think the Vix is high, at 33. Or that implied volatilities look very high. And that the index is likely to be seriously volatile after the 16th, when the election results are announced. But is there a play till then?


Options are extremely short term plays as well as long term strategies. In the short term – for say a week or so – does it make sense to sell options? (Straddles or Strangles)

The Nifty 6700-6800 strangle is at Rs. 437. Let’s assume we go short that straddle today (Friday). With implied volatilities the way they are, what is the situation today? (Assume a position of 500 Nifty each)

Optionalysis: Writing Options Fraught With IV Rise Danger, But Risk/Reward Favourable

But, assume that we wrote this strangle today, and we waited till Wednesday (7 May). If the implied volatility was the same (around 33% averaged) we will see the graph change this way.

Optionalysis: Writing Options Fraught With IV Rise Danger, But Risk/Reward Favourable

The same position profits about 23K over five days, if Implied volatility is the same. The exposure is about Rs. 10 lakh (at Rs. 1 lakh per contract, 10 contracts).

And, the range of profitability is between 6480 and 6980, a fairly wide range.

What if Implied Volatility goes up?

For the position to see losses IVs need bump up to 37% average.

Optionalysis: Writing Options Fraught With IV Rise Danger, But Risk/Reward Favourable

And this is the bet – would you think implied volatilities remain the same?

A bump up from 33% to 37% isn’t that much – after all, we’ve seen average volatilities go from below 20 to above 30 in a month!

The VIX is up 6% today already. And it’s likely to go to 40%+ by the 16th. It’s a big risk to make assumptions on implied volatility.

But the risk/reward is favourable for writing options – the losses made on a sharp VIX rise are lesser than the gains made if IV remains the same (or falls). In the above example, a 4% increase in IV in four days results in a Rs. 8,000 loss, but the same IV in 4 days is a Rs. 23,000 profit, on an exposure of Rs. 10 lakh.

We would bet on the side of writing options but with 50% of the quantity we would normally bet. This is our strategy over the next week. Note that this is fraught with serious risk!

Note: How did we get those graphs? We used Options Oracle, added positions to the chart, and use the “Graph” option. You can then cycle between now and the expiry date to find out how your option position will move, and change Implied Volatility too.

Optionalysis: Writing Options Fraught With IV Rise Danger, But Risk/Reward Favourable


Nothing in this newsletter is financial advice and should not be construed as such. Please do not take trading decisions based solely on the matter above; if you do, it is entirely at your own risk without any liability to Capital Mind. This is educational or informational matter only, and is provided as an opinion.

Disclosure: The authors at Capital Mind have positions in the market and some of them may support or contradict the material given above, or may involve a direction derived from independent analysis.



  • vivek says:

    I’m taking the other side of this bet with a 6400-6900 strangle I bought today for a total cost of 279. As discussed in Google groups. Lets see how it goes.
    Vega is more than Theta now so its profitable if IV rises more than 1% every day (on average) for the next 5 days. Maybe the exit poll will remove uncertainty and dampen IV in which case maybe will hold position only till 13th (otherwise will hold till the 15th). Will have to take a call next week.

    • My trade is done 🙂 It was a one week play, and I think the time value loss has been good and useful, but not great. I think you’re right in your approach now, but it’s a bit of a risk since now time decay is higher going closer to expiry.

      • vivek says:

        Woot, I did not expect such quick profits on my position. The strangle has moved from 279 to 378 in one day! 35% return. The IVs have changed from 37.5 to 43-45 which is what I was hoping for.
        Win or lose, I wanted to track the IV numbers this time as they had been breathtaking in 2009 and I wanted to compare. The put and call IVs on 10% OTMs had peaked at 50% and 65% (1 day before results). Right now, this is where we are at:
        8th May: 6400 Put: 132, 6900 Call: 150 (Nifty 6657) IVs 37.5/38
        9th May: 6400 Put: 101, 6900 Call: 277 (Nifty 6859) IVs 42.7/45
        Theta is 3.5% per day
        Risk of losing quick is there if market reverses or IVs just decide to come down. Hard to know how long to hold the position now. I guess best case scenario is if we get close to 50% IV on Mon/Tues. Maybe that is the point to close the trade.

        • Very good move. I had short calls yesterday, I went long 6800 calls today on the open (since the future bounced off that long term 6700 support shown in the post) – and used the June call which had lower IVs and would lose less time over the weekend. That’s gone up 40% or so.
          It’ll be interesting to trade up the trend and see where the markets go on Tuesday. But yes, the strangle should continue to work if IVs keep moving up!

        • vivek says:

          Nice trade!
          The strangle was worth 422 at close today. Closed the trade at ~50% gains.
          12th May: 6400 Put: 70, 6900 Call: 352 (Nifty 7014) IVs 46.47/47.44
          I thought about delta hedging by buying more puts, which would lock in the profits, while still playing for more IV and gamma. But, IVs seemed high enough at 47 so I didn’t go for it. Actually, I’m not sure why the IVs in your post are significantly lower. I’ve been using ICICI Direct’s IVs. I hope they calculate properly otherwise the IV numbers here will be useless and there may be more IV upside possible.
          It will be interesting to track how these options do for the rest of week.

        • Well done! I got out of my long calls as well. Now long puts. but this is just directional craziness. Let’s see where your strangle goes!

  • vivek says:

    Strangle close: 396
    13th May: 6400 Put:35, 6900 Call: 361 (Nifty 7109) IVs 41.1/40
    We got the IV sucked out of the options based on the post poll survey releases, as usually happens post event announcement. Although, the actual event is on Friday so we could have IVs go back up. Its been a two part event situation and one gets the feeling that the first part event might have been the main play in the context of the strangle.
    Nonetheless, I was wondering about a rinse-repeat trade for the next two days with a 6900/7400 strangle. Decided against it for the moment…
    13th May: 6900 Put:124, 7400 Call: 101, IVs 35.2/34.8

    • Great stuff mate. Interesting to see how it’ll play out Wed and Thu. Unless there’s some adverse news, IVs should stay low, no? As you said, the big thing is done already. Save for surprises, IVs should stabilize into the event…

      • vivek says:

        Strangle close: 411
        14th May: 6400 Put: 38, 6900 Call: 373, IVs 43.5/43.5
        Strange2 close: 254 (up from 225)
        14th May: 6900 Put: 136, 7400 Call: 118, IVs 38.7/38.7
        I thought IVs at 35 were cheap yesterday and today morning. I wasn’t able to trade today or else would have looked into strangle2. If it was a good buy in the morning. IVs have gone up 2-3 points today and could go up more tomorrow. Even if they don’t go up much and stabilize, they shouldn’t go down either so it was a fair trade to try. Now, I’ll just be a spectator. 🙂

        • Well done 🙂 IVs likely to go up a little as VIX goes up to 34. But the Strangle 2 is going to be fun, I think…

        • vivek says:

          Strangle close: 445
          15th May: 6400 Put: 50, 6900 Call: 395, IVs 49.88/47.44 (Nifty 7123)
          Strangle2 close: 289
          15th May: 6900 Put: 154, 7400 Call: 135, IVs 44/42.5
          So, rinse-repeat would indeed have been fun with a 28% return in less than 2 days, which is pretty good if one considers that the market is flat over the trade period of last two days. If we had got a directional move as before the first part event, this strangle might have done even better.
          Well, now IVs might peak in the morning before the poll results announcements and then get sucked out after the announcement, with or without a directional move.