The VIX set another new intraday record today, topping out at 89.53.  As a reminder, the VIX is a measure of the average 30 day volatility of the S&P 500.  A reading below 20 is normal.  Over 30 is rare, over 50 is extremely rare, and levels near today’s high at just below 90 are simply unimaginable. Here is a 5 year chart of the VIX to show what I mean.


How can a high VIX help us? – Option traders can love and hate extreme volatility like we see in today’s market.  On the one hand, they hate it, because the cost of portfolio insurance just went up significantly.  But in the same respect, if you are seller of options, as is the case with either writing covered calls or selling naked puts, then high volatility can be your friend.

Pricing of options -There are 6 components that go into the pricing of options – stock price, strike price, risk free rate of return, time to expiration, dividends, and volatility.  Many covered call writers prefer to write at the money (ATM) covered calls, meaning if they buy a stock for $50 per share, then they would sell a 50 strike covered call option against it.  They also tend to write covered calls somewhere between 1-2 months prior to expiration.  The risk free rate of return and dividends(especially when dividends are small) are minor components of pricing options.  The implied volatility of the stock market can have a huge impact on the pricing of options, whether for portfolio insurance (buying puts), or collecting premium (selling covered calls).

Volatility and Strike price case study on covered calls -Take a look at the chart below that models the 56 day covered call prices for a $50 stock.  The 56 day example is based on today’s date (October 24th), and the December options expiration (December 19th), which is currently 56 days away.  You can download the geldpress option calculator here, and modify it at will.

Explanation of the chart above:

  • Assumption:  Buy 100 shares of a $50 stock, and sell to open (1) December Call.
  • The at the money (ATM) strikes are highlighted, but in the money (45 strike) and out of the money (55 strike and 60 strike) are also listed.
  • From today (October 24), there are 56 days until December expiration.
  • Notice that as the volatility increases, the premium collected for selling covered calls goes up dramatically.  Covered call writers LOVE the high volatility of today’s markets.
  • Selling a 50 strike December covered call with an implied volatility of 70 yields $552.07, which is over 11% time premium (552 divided by 5000).  Getting called out of this position results in an 11% return on investment in just 56 days!

For additional information on:

The Volatility Edge in Options Trading: New Technical Strategies for Investing in Unstable Markets
The Volatility Edge in Options Trading: New Technical Strategies for Investing in Unstable Markets by Jeff Augen