Credit Spreads and Implied Volatility

This is sort of like one of those fishing stories about the one that got away. For two days I had an open order to sell my put spread and had provided what I thought was more than sufficient room to allow the market maker to make a profit. I was well off the mid-point of the bid / ask spread. In fact, I had lowered by limit to my lowest acceptable credit.

Needless to say, I was not filled but it would have been a beautiful thing if I had been because I would now be poised to open a call spread with the market rebounding yesterday and again today.

With the rally, my plans for the put spread are discarded and I will have to evaluate everything from square one. The closest I dare sell a put spread is 1,385 and today I would receive a very slim price for the sale.

In selling a put spread, not only am I battling against the directional move of the index but I am also having to contend with a volatility level, as measured by the VIX, that is currently at its historic lows. The story is the same on the call side. There simply is not enough premium available at the strikes I would want to sell.

The above graphic reveals a Volcone demonstrating where Implied Volatility lies relative to historic volatility of the index measured over the last 12 months. The two dots represent current IV readings for the ATM March put and call options. The puts carry slightly more IV.

I do not want to push things and try to sell a spread closer to the money because if this rally has legs it will cost me. It is better I simply miss out one month and avoid the potential loss.

I am in a "sidelines" mode. I missed the opportunity to sell a put spread when the market corrected within its trend and the premiums are too thin on the call side. No order will be placed, but I will continue to watch things on the SPX to see if opportunities develop.

In the meantime, the extreme low reading on the VIX does suggest that it may be an good time to get long on Vega. That does not help us with a credit spread strategy, but there are other strategies that can take advantage of low volatility environments.

Christopher Smith
TheOptionClub.com