When is There Not An Edge to Sell Premuim?

In the financial industry, the likelihood of outlier moves has been a constantly argued subject. This is especially true when it comes to derivatives products, specifically options. How often do the 3 std deviation, 2 std deviation, or even 25 std deviation events occur? Now I do not want to turn this into a mathematical article at all. In fact the way I will look at this just might make a mathematician cringe. However, lets take a look into some of the facts.

1. When volatility is above its mean to is a time to sell volatility.
2. The seller of the options wants implied volatility to forecast greater moves than realized volatility will be.
3. Not all stocks are good products for premium sellers because implied volatility is consistently wrong in predicting the actual moves/volatility.

Therefore, lets take a look at the opportunity this presents us. As we all know, many individual stocks are much more volatile than the stock market indices. This means historically indices have performed well for the short premium side not including some large outliers (i.e 2008-2009 crisis). Despite this, historical volatility tends to stay above implied volatility most of the time. This means volatility is low and continues to contract. The large opportunities in indices come only when there are large discrepancies in the volatility. However, this is looking at it on a long-term level.

However, if we were to expand our range to more range bound volatile indices like emerging and global markets we have more risk, but we have much more decent opportunity of implied volatility outweighing realized volatility.

If we were to sell premium in global indices we would overall have the edge. Even statistically index short premium works (You would especially know if you have ever watched the Karen the Super trader interviews). However, in individual stocks, commodities, currencies, and extremely volatile markets these rules do not always hold true. In fact, we will often see outliers where long premium makes sense. These are often the high flying stocks like TSLA or NFLX. Sometimes they are even commodities such as Natural Gas. However, overall short premium still wins, but the premium sellers (usually me) can get burned severely in these underlyings that have such large moves.

What we also must understand is that stocks/markets that behave this way take a long time to mean revert. For example, TSLA has consistently had a discrepancy of realized volatility being much higher than implied for months (you are looking at weekly charts BTW). It is also the same with NFLX. These stocks are premium buying stocks, and these are stocks that I try to avoid selling volatility in. However, when the discrepancy goes the other way their is opportunity.

This is also how I like to use historical volatility in conjunction with IV Rank. I try to look at both before I make a decision. This is especially true when I try and enter a core position where I plan to be short for a while because their is a large discrepancy. My point in all of this is simply "make sure you being paid for the risk you are taking." I always prefer short premuim and even with "undefined risk", but I don't want to be caught in those scary outliers.

Also, I suggest you read this article from Al Sherbin. It is some very interesting views on AAPL historical distributions.
 
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