How to use correlation in options
Constantly adding high probability of profit positions to our portfolio is how we generate an attractive return on capital.
What's exciting is that new opportunities develop on a daily basis, as markets move and new products come into how to use correlation in options market. As we build on previous experience and add to our skillset, it also becomes easier to recognize attractive risk that that fits our personal risk profile.
It's for this reason that we want to specifically highlight a recent episode of Options Jivewhich presents information and historical data that may help you when filtering the market for trade ideas in single stock positions. As a reminder, single stocks are unique because they are exposed to both systematic and unsystematic risk.
In market terms, systematic risk essentially binary options indicators 2020 to the risk of being in the market and can affect any financial asset. For example, if a worldwide recession were to develop, almost all of the market would be affected in one way or another.
Pros and Cons of Correlation
Systematic risk is also called "undiversifiable risk" for this reason. However, single stocks are additionally exposed to "unsystematic risk," or risk that is specific to one company or industry. For example, if the worldwide supply of lithium suddenly dried up, companies that rely on this resource to make batteries cell phone manufacturers, electric car manufacturers, etc Due to the added complexity involved in trading single-stock volatility, the aforementioned episode of Options Jive who trades options valuable insight into metrics traders can use to help find suitable opportunities.
Generally speaking, market correlations get higher during market selloffs, which is why these types of markets are often accompanied by an increase in the KCI. From a practical standpoint, consider that when anxiety is heightened market participants discriminate less about which assets to sell - so they all move down.
Now you are likely asking yourself - how does this information help me?
- The Implied Correlation Index is a financial benchmark published by the Chicago Board Options Exchange CBOE that tracks the correlation between implied volatilities of options listed on an index and the implied volatilities of a weighted portfolio of options on the components of that index.
- Correlation - bacaniplaza.com
- Dispersion Trading Correlation describes the mutual relationship between two independent values.
The key point is that as the market falls which likewise translates to a rising KCIcorrelations between index option prices and single-stock option prices are increasing. Given what we know about systematic and unsystematic risk, this might help illustrate why selling index premium may be more attractive during down markets.
Using the same reasoning, when the market is rallying, and the KCI is dropping, this also shows why a decreasing correlation between index options and single-stocks may make the latter group more attractive.
In periods of complacency, single-stocks simply have more inherent risk premium available to sell. It's important to note, that no matter the characterization of the broader market, unsystematic risk is always present in single-stocks, and traders need to be fully cognizant of such risks prior to entering these positions.
Using historical stock how to use correlation in options options data from to present, a study was conducted that examines the relative performance of 8 single-stock positions deployed when VIX was high above 15and when VIX was low While both approaches achieved an attractive win rate, the results show that on average returns were higher in single stock premium sales when the VIX was low i.
KCI low - as you can see in the image below: It's possible that your risk profile may not allow for trading single-stock options. However, if you are evaluating opportunities in this space, it might be worth checking on current levels in the KCI and consider the overarching themes in the broader equity market to help assist with identifying the appropriate exposures.
Given the importance of this topic, we hope you'll take the time to review the complete episode of Options Jive when your schedule allows. We also hope you'll follow up with any comments or questions in the space below, or by contacting us directly at support tastytrade.
In the meantime, happy trading!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.