Skew(ered)
GLD options volume again crapped out, and call volume remained anemic all week, so we'll be back to a sell bias on Monday.
On to volatility and the skew of options prices.
The vol skew sounds scary, but it's just a product of the behavior of what you're trading. Basically, if down is faster than up by a lot, you'll have a strongly negative skew. Take IWM, where since 2007 vol looks like this:
STDev of vol when down over a period of 15 trading days: .0614, corresponding to an annualized vol of 25.6%
STDev of vol when up over a period of 15 trading days: .042, corresponding to an annualized vol of 17.52%
Skew can be seen by a quick glance at the options chain: implied vols run from 25.63% on 64 puts to 17.02% on 71s, from April (notice how close these are to the figures above).
Meantime, over at GDX, the figures look like this:
STDev of vol when down over a period of 15 trading days: .0886, corresponding to an annualized vol of 36.92%
STDev of vol when up over a period of 15 trading days: .0859, corresponding to an annualized vol of 35.81%
Skew on this is nearly flat, as you would expect from the above: implied vols run from 37.87% on 40 puts to 32.83% on 47s, from April.
As can be seen from the above, higher means decreasing vol, which is why there's a positive correlation between VIX/RVX and rising prices. This relationship is far weaker for GVX and gold prices. Indeed, GLD skew is a slight "double" skew, that is, declining as you get higher and nearer to the money, then rising as you get higher and farther out of the money.
I had thought that after last year's rise, we'd go back to choppy, but that's not what's happening. Sideways conditions or conditions friendly to iron condors are of course far more likely to happen in a gently rising market like we have now than in the far more choppy conditions we had during the crisis.
But that also means playing the iron condor can allow for using strikes nearer to the money for the call side on IWM. (I would never play an iron condor on GDX, by the way. Gap opens are way too common.)
Looking at the above vol figures, the 71 I sold on Friday is right in line with what you could sell given the vol on the positive side for IWM. The 64s are still the correct one given the current price and the above vol for the negative side, if doing Aprils.
That should mean being able to make somewhat more money when doing this on the RUT itself.
But there's a sting in the tail of the negative side, which you can see by doing a frequency distribution. The maximum move is pretty much equal for up or down in recent times for IWM: 30.4% on the plus side, 33.2% on the negative side, over this time period. But moves greater than 22%, which is as far out as I took the distribution for both sides, tell you where the extreme moves are most likely: 16 instances on the negative side, only 5 on the positive side. Looking more closely, on the positive side frequencies are very stable and only really begin to decline once it's greater than the median on the plus side, while on the minus side they start falling away immediately. Plus side looks like one half of a normal distribution, minus looks more like a Pareto, with the 80% point coming at around 8%. Plugging that in gives you an annualized vol of 33.35%, which would call for a low strike of 62. So, that would probably be how I'd do the put side of a condor on the RUT, to be safe, which of course would lower the profit potential of that side correspondingly. On both IWM and RUT the 62/71 620/710 put/calls are about the same price, so obviously someone besides me has noticed these things. Wotta surprise.
