Guys. Look at my inbox.
I'm really glad folks here are excited about my recent posts. It sounds like it's really been helping folks out. I don't claim to know everything (or really anything) there is about trading, but looking at options as a volatility instrument rather than a directional instrument has really improved my trading over this last quarter. That's not to say I'm a good trader, just a less bad one. Maybe one day I'll be a good one. A lot of this comes from having better data through my tools.
My Workflow and Tools
- Find a trade
- Analyze the trade
- Stress the trade
Finding a trade
Finding a trade comes from a couple of places. One is listening to good traders. Ever since I started studying volatility traders specifically, a whole bunch of trade opportunities have become apparent. (That's not to say directional traders are worse in some way, I just can't seem to get the hang of it, either daytrading or value investing. There's only two directions, up or down, and somehow I always pick the wrong one.) Someone I know shared an interesting idea for short TSLA vol trade that came from listening to a market podcast where someone mentioned elevated 1 yr volatility as a throwaway comment.
The other comes from running scanners. I trade through ETrade and their platform has a few naive ones, "unusual options activity," but I personally cannot figure out how to extract useful information out of that, it's too vague. I have to do a lot of extra research on top of that. The other tool I use is the Predicting Alpha Terminal. Half of you came here just to see that, so you can basically close this post and move on with your lives. It has a scanner baked in for general vol trades and a specialized one for earnings trades. There's also a bonkers video/educational library that has helped me immensely. I'm not shilling, I just pay for the product and it's really good for what I'm doing. Full disclosure, subscription comes with discord access so I do get to chat with the founders (it's a small startup) every now and again.
As an example, here's a scan I ran just now, filtering out penny stocks, limiting it to stocks which have an elevated IV Rank, looking for things where IV is greater than the forecast volatility, I found this.
Analyzing the trade
No surprises here, I do most of the analysis in the PA Terminal. I just took the findings from the scanner and fed it into their volatility analyzer. It looks like the iShares 10 year bond ETF (IEF) has a 30 day short volatility opportunity. At this point I would probably go to yahoo finance (I know, boomer website) and see what exactly it holds and maybe try to figure out why the 30 day vol is elevated. You might think it's just from recent bond market stuff, but TLT and LQD have normal looking vol cones. EMB also has this elevated 30 day thing, so maybe there's some event happening in the next 30 days that affects just these two ETFs. This warrants more research.
Stressing the trade
You've seen this one, I stress trades in Thinkorswim. On the downside with a 3% move and a 6 point spike in volatility to historical max, you're looking at a loss of $150 per lot. On the upside, it's ~$200 with a 9 point drop in volatility, but depending on what you think is causing the 30 day spike, this might be a super high conviction trade.
Also it's worth verifying that your numbers match up. TOS is giving me different volatility numbers for the 30 day expiration, but matching ones at 20 days. It's possible that this comes from bad liquidity on the ETF, wacky after-hours numbers, who knows. This isn't a real trade, this is just an example.
And that's it, that's my workflow.
BONUS TRADE
That IEF thing was just an example of a thing I found while casually looking at the scanner. Here's the actual bonus trade. So some ideas come from good traders or actively searching. This one came from "Huh, I wonder what bitcoin is doing." There's an ETF, BLOK, which tries to pretend it's not just a bitcoin ETF but it only invests in mining companies or holding companies, so it's a bitcoin ETF.
Here's the vol cone. Elevated across the board and flat as a pancake. Near all-time-highs in the longer dated tenors. It's a short vol opportunity. Stressing it to a 10% move with +30 vol gives a loss of -800 per lot. A winning position is a drop of 60 vol points to the third quartile, max of $2000 per lot, breakevens at a 35% crash or a 75% rally.
Two things to be aware of. I have no idea why the vol cone looks like that. It holds a bunch of companies in small amounts, 5% each. I can't find any obvious correlations with anything except for the BTC-USD price. Second, I don't know if any of my numbers make sense. I expect mean reversion, but will it go down? Is it establishing a new median? Is a 10% move on a blockchain ETF sensible? Do the previous volatility highs represent an upper bound? It's bitcoin, who knows! NFTs are apparently digital beanie babies and all the rage, so... maybe it's that? Personally I am indifferent to crypto despite its crazy returns the last few years, so I can't make sense of these numbers. But if you're a crypto-enthusiast, maybe there's something for you there. All I know is that the weird shapes on this graph tells me something is mispriced and if you're smart enough, you can take advantage of it.
Conclusions
The PA terminal is expensive (80/month) but I can't trade vol effectively without it. It easily pays for itself by filtering out the number of losing trades I used to make, making the winners that much more valuable. If you're on the fence about it, they're about to release a new version that's supposed to be easier to use for novice traders and it'll come with a week free trial. They've been mentioning it on their youtube streams the past few weeks, which is also a great resource if you want someone else to do earnings analysis for you. I think they're taking folks in manually by email? Check the live streams to be sure.
If you do get it, the one downside is that there's a lot of educational material. It's designed to make you a better trader and to help you create your own strategies, but I felt lost with regards to "what can I do right nowwwwwwww." If that sounds familiar, I highly recommend you go straight to the earnings strategy as something that is mechanically, immediately actionable for smaller accounts. After earnings season is over (next week or two, I think), gamma scalping is probably going to be your go to play. If your portfolio is big enough, you could probably go straight to shorting vol on SPY or running backspreads on it to capture skew.
Edit: I confirmed that if you want in on the free trial, send an email to sean@predictingalpha.com. Don't tell him I sent you, he might read my posts and find out how badly I've misunderstood their educational material.
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