Selling Low Risk Calls in Volatile Markets (No, really)

When people refer to volatile markets, they often mean the market has dropped. The truth is that volatility is direction agnostic. While puts certainly can increase tremendously in value with the increase in implied volatility as markets plummet, we can see an increase in IV in the calls as well.

On 2/28/2020 after one of the “WORST WEEKS EVER!!!” (see related article about staying calm here…), I took advantage of the higher implied volatility to sell some calls in Square (Ticker: SQ):

Square (SQ) on 2/28/2020

What can we learn from this chart? Square has dropped only a tiny bit (closed on 2/21 at about 83.50) during the week while the rest of the market has plummeted. Earnings were on 2/26/2020, so there is no significant micro event coming up. Note also that Implied volatility is at 52 week highs, along with much of the rest of the market.

I am currently long January 2021 60 calls and took advantage of this Extremely high IV to sell 93 calls expiring on 3/6/2020 for 1.05. For these calls to expire ITM, we would need SQ to rally over 11% in one week. Possible – absolutely. Likely? Absolutely not. The straddle (or “over/under” for those familiar with the betting line in sports) was at 8.85, so the market assumed SQ would move about the same within a week.

Here is where SQ is through 3/4/2020:

Square (SQ) on 3/4/2020

SQ is down a bit more than $4 and Implied Volatility has really started to come down. I took off the calls on 3/3/2020 for 0.02. Within 2 days, the IV drop plus SQ backing off led to a profit of $103 per call sold. As we were long calls at 60, the risk in the call sell was extremely low. This coupled with the low probability of the calls being in the money led to a low risk profit in a volatile market. Note had SQ been above 93 this Friday, I could have sold the long calls and short calls for a big profit or rolled out the short calls.

Takeaways – when the market is volatile, IV tends to rise across the board. Some stocks will not drop as much (recently stocks with a stay-at-home bias and some with excellent earnings). You can often find some calls at very attractive levels to sell against your long positions and pull in some “easy” profits.

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