Yesterday we closed a GOOGL put fly for a small profit. We had placed the trade when the stock was at 700 with the though that a consolidation or slight pull back would mean the stock had a decent chance of being 650 or so in the next month. We targeted that level. Here was the original trade followed by the update from closing it yesterday:
Trade: GOOGL ($700) Buy Sept 700 / 650 / 600 Put fly for $12
-Buy to open 1 Sept 700 Put for 21
-Sell to open 2 Sept 650 Puts at 5.50 each or 11 total
-Buy to open 1 Sept 600 Put for 2
Rationale: This targets a pullback in the shares similar to what we saw after earnings. Implied vol is slightly higher today and the fly alleviates some of the premium risk associated with an out of the money trade here.
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Update: Sold to close GOOGL (639) Sept 700/650/600 put fly at 16.00 for a $4.00 profit
So closing a trade for a small profit certainly beats losing money but the trade was a little disappointing in that we got the direction SO right.
So what happened? Volatility happened. Since this was a butterfly, not only did we need the stock to go our way, we also needed implied volatility to stay sane. When vol spikes like it did it counteracts a lot of what could be gained by being correct on the delta positioning. GOOGL, like most stocks, got pummeled in the panic, briefly trading below 600 (our low strike in the fly). Implied vol spiked as a result. We were patient intra-day and let the market rally, bringing GOOGL within striking distance of the sweet spot. When we took the trade off, GOOGL was trading 639, near its highs of the day. But even with the stock only 11 dollars away from our fly’s center we only made 4 dollars. Here’s the visual why:
Implied vol almost doubled in the last few days’ sell-off, killing the profit potential of the trade.
Here’s an easy way to understand why (and remember for the future.) Essentially the implied vol input in options is the odds of being able to predict where a stock will be on expiration. The higher the vol, the more uncertainty reflected as to where the stock will end up. The lower the vol, the more certainty reflected. So when vol spikes it’s increasing the price of all option premium. And when a trade is in-the-money that means there’s less certainty that the stock will actually stay in-the-money for that spread. When a trade is out of-the-money the opposite is true.
When GOOGL was 739 (when we closed), if vol had remained unchanged from where we initiated the trade, we’d have had a big winner on our hands. That’s because there’s more certainty that we are going to be right ultimately. But with the stock moving all over the place, vol spiked, due to increased uncertainty. The odds of GOOGL being at 550 or snapping back above 700 suddenly increased when the market went berserk.
I mentioned that increased implied vol would mean the opposite for out-of-the money trades and the best way to think of that is if GOOGL had been below 600 on the close but with implied vol much higher our trade would have been much less of a loser outside our range than had vol been the same as at entry. That too reflects greater uncertainty. When a stock drops 100 points in a straight line, bouncing back 50 dollars higher just doesn’t seem as big of a deal anymore.
This holds true for other spreads, not just flies. If you owned, say, the 700/600 put spread yesterday it would also have been frustrating when vol spiked because higher vol would have offset a lot of your delta gains as that 600 put spiked in premium. Conversely, if you owned the 625/600 put spread right now (out-of-the-money with stock at 635) it’d be worth a lot more with vol at 36 than at 22.
So had we waited a day and with the stock at the same place as we closed yesterday, that fly probably would have been about 18, not 16 for an extra 2 dollar profit. That would have almost entirely been a result of implied volatility in September being down about 6 points today, reflecting slightly more certainty that GOOGL will stay within the 600/700 range on September expiration than it looked yesterday at about 9:35 AM.