[Options] Selling Some Elevated Premium

Sean McLaughlin
May 12, 2021

Welcome back volatility.

Three days off the highs for the S&P 500 and twitter traders are acting like the sky is falling. And maybe it is? But at times like these, I like to look for opportunities to fade what often prove to be short-lived spikes in volatility.

And the best way I know how to do this is to look at sector ETFs and observe the ones displaying the highest relative implied volatilities.

Today, the one at the top of my list is the Biotech Sector ETF $XBI.

Here's how $XBI implied volatility has trended over the past year, and notice the recent trend higher:

Looking at the options chain in June (37 days until expiration), I see that I can get some pretty juicy premiums for out-of-the-money calls and puts with 20 deltas. This gives us a bit of room to be wrong. And it just so happens that the put strike falls below last summer's highs for $XBI which are now acting as support. And the call strike rests right around where XBI hit resistance in its latest attempt to push higher in late April.

Here's the Play:

I'm selling an $XBI June 115/140 Short Strangle for an approximately $3.20 credit. This means I'll be naked short an equal amount of 115 puts and 140 calls. This position has theoretically unlimited risk and therefore will require larger margins than normal (approximately $3500 per one lot).

Because of the unprotected short options, I'll pay close attention to this position as it nears my short strikes.

If $XBI closes above 140 or below 115 at any time during this hold, I'll close the entire position down (win or lose) to limit any further downside. This will be no time to get cute. I'll just close and move on.

In the meantime, I'll leave a resting order to close this position for 50% of the net credit I received at trade initiation. So if I enter at 3.25, I'll look to buy it back at 1.60. I'm not greedy with positions like this. I want to take the "easy" profit and let somebody else sweat out the last half of the potential profits all the way to expiration.

~ @chicagosean

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