This account is pending registration confirmation. Please click on the link within the confirmation email previously sent you to complete registration.
Need a new registration confirmation email? Click here
TheStreet Open House

Volatility Fundamentals

One of the reasons I think my OptionsProfits colleague Dr. Paul Price has been "filling pockets instead of filling teeth" over the last few decades is, he pays attention to the fundamentals. For a longer-term, value stock investor like him, that means price earnings ratios, forward multiples and dividend yields. However, for option traders there are more than just stock fundamentals. There are also volatility fundamentals.

Volatility fundamentals are things many traders would do themselves a huge favor to learn ( something we concentrate on teaching at Option Pit). Instead of P/E ratio, one might look at historical volatility vs. implied volatility (HV/IV ratios). Options traders should pay attention to 52-week lows and highs in implied volatility instead of stock price. Options traders worry about skew and term structure instead stochastics and fibonaccis.

This is how I came up with the trade I am looking at today. Eli Lilly (LLY) 30-day implied volatility is trading at its lowest level in over two years and is trading at a significant discount to both 60-day and 90-day implied volatility. As a trader who likes fundamentals of options, this is telling me that I should really consider buying premium in the options.

Because the implied volatility is so low, I have many options in trading options. I could buy puts, calls or even a straddle. In the past week, the stock has had a range almost as great as the value of the April 35 straddle. That seems like a really decent buy. I would not fault any trader that took no direction and simply bought premium.

However, I am willing to stick a leg out there. The stock seems to be bouncing off of the lows right now and the April 35 calls are incredibly cheap in my opinion. Thus, rather than buy a straddle I am going to buy a bullish call. I do not need more than $0.25-$0.30 of a rally for this call to really start working; at that point if implied volatility is higher I could leg into a butterfly, call spread or simply exit the trade with a profit. I would be looking to make a 75%-100% gain on the call and would only look to exit if the call price fell below $0.30.

Trade: With LLY trading at $35.00, buy to open LLY April 35 calls for $0.63.

At the time of publication, Mark Sebastian held no positions in the stocks or issues mentioned.

Mark Sebastian is COO and Director of Education for Option Pit Option Mentoring. Sebastian is a former market maker on both the Chicago Board Options Exchange and the American Stock Exchange. Along with his role directing the path of education for Option Pit, Mark is currently the Director of Risk for a private hedge fund. He started the popular blog Option911, which is now the Option Pit blog. Sebastian has been published nationally on Yahoo! Finance, is a featured contributor for TheStreet's OptionsProfits, SFO, OptionsZone and is the managing editor for Expiring Monthly: The Option Traders Journal. Mark has a Bachelor's in Science from Villanova University.

OptionsProfits For actionable options trade ideas from a team of experts, visit TheStreet's OptionsProfits now.

Readers Also Like:




Readers Also Like:



Readers Also Like:

Select the service that is right for you!

COMPARE ALL SERVICES
Action Alerts PLUS
Try it NOW

Jim Cramer and Stephanie Link actively manage a real portfolio and reveal their money management tactics while giving advanced notice before every trade.

Product Features:
  • $2.5+ million portfolio
  • Large-cap and dividend focus
  • Intraday trade alerts from Cramer
  • Weekly roundups
TheStreet Quant Ratings
Try it NOW
Only $49.95/yr

Access the tool that DOMINATES the Russell 2000 and the S&P 500.

Product Features:
  • Buy, hold, or sell recommendations for over 4,300 stocks
  • Unlimited research reports on your favorite stocks
  • A custom stock screener
  • Upgrade/downgrade alerts
Stocks Under $10
Try it NOW

David Peltier, uncovers low dollar stocks with extraordinary upside potential that are flying under Wall Street's radar.

Product Features:
  • Model portfolio
  • Stocks trading below $10
  • Intraday trade alerts
  • Weekly roundups
Dividend Stock Advisor
Try it NOW

Jim Cramer's protege, David Peltier, identifies the best of breed dividend stocks that will pay a reliable AND significant income stream.

Product Features:
  • Diversified model portfolio of dividend stocks
  • Alerts when market news affect the portfolio
  • Bi-weekly updates with exact steps to take - BUY, HOLD, SELL
Real Money Pro
Try it NOW

All of Real Money, plus 15 more of Wall Street's sharpest minds delivering actionable trading ideas, a comprehensive look at the market, and fundamental and technical analysis.

Product Features:
  • Real Money + Doug Kass Plus 15 more Wall Street Pros
  • Intraday commentary & news
  • Ultra-actionable trading ideas
Options Profits
Try it NOW

Our options trading pros provide daily market commentary and over 100 monthly option trading ideas and strategies to help you become a well-seasoned trader.

Product Features:
  • 100+ monthly options trading ideas
  • Actionable options commentary & news
  • Real-time trading community
  • Options TV
To begin commenting right away, you can log in below using your Disqus, Facebook, Twitter, OpenID or Yahoo login credentials. Alternatively, you can post a comment as a "guest" just by entering an email address. Your use of the commenting tool is subject to multiple terms of service/use and privacy policies - see here for more details.
Submit an article to us!
DOW 17,239.64 +82.79 0.48%
S&P 500 2,008.93 +7.36 0.37%
NASDAQ 4,583.9110 +21.7220 0.48%

Brokerage Partners

Rates from Bankrate.com

  • Mortgage
  • Credit Cards
  • Auto

Free Newsletters from TheStreet

My Subscriptions:

After the Bell

Before the Bell

Booyah! Newsletter

Midday Bell

TheStreet Top 10 Stories

Winners & Losers

Register for Newsletters