A little know fact- in 1989, I was one of the few people on the PSE Option trading floor when the earthquake hit in San Francisco after the close. I was running some sheets (we traded from paper sheets back then) and our technical analysis guy was looking at his charts. The earthquake was long enough where we looked at each and said "Holy $&%@, this is a big one." It was also my introduction to technical analysis. What did I learn since then?

Every Ship at the Bottom of the Ocean has a Chartroom.

And

Some people are very good at reading charts.

I think it is very hard for most people to jump into the latter group. It takes time and practice. What I like about options in general is, they are forward looking instruments. Where does the market think a stock is going?

Just look at the options prices. The key difference is how Historical Volatility (movement of the underlying) and Implied Volatility (option volatility derived from market prices) trade.

Historical Volatility HV (HV10, HV30, HV60, HV90) looks backward to how the stock has moved.

Implied Volatility IV (IV10, IV30, IV60, IV90) looks forward to how the market thinks the stock will move.

I will drill down using Aqumin AlphaVision 3D chart to illustrate this point with the S&P 500 ETF (SPY).

SPDR S&P 500 ETF (SPY) Volatility
Source: Aqumin

View Chart


Here, I have the SPDR S&P 500 ETF (SPY) - Get Report (all the strikes) where building height is implied volatility. Color is Current Implied Volatility (IV) less the HV10 (10-day moving average of the underlying volatility in the ETF). All the green in the out-of-the-money options is the skew (IV is greater than HV10). If you want to sell options based on a read of the HV10, this is where the edge is. The implied volatility for each strike increases as the puts get more out of the money (taller buildings). Notice the band of white across each strike month. There the implied volatility is about right on with the HV10. There is not a lot of edge right now with the at-the-money and just out-of-the-money options in the SPY because they are trading very close to the HV10 in the near-term months. Also note, the old school chart at the bottom right for the series I selected, the implied volatility has fallen off a cliff. The question for now is, should the market be pricing the at-the-money options at the current HV10 (very low) going out in the SPY? It would seem the expectation is lower Implied Volatilities ahead. That is how I read this chart. Let's see if I am right.

At the time of publication, Andrew Giovinazzi held no positions in the stocks or issues mentioned.

Andrew is the Executive Vice President of Business Development for Aqumin, where he participated in the design team to apply AlphaVision to the financial markets. For 15 years he was a member of the Pacific Exchange and the Chicago Board Options Exchange, where he actively made markets and traded in both equity and index options.

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