Market Measures

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Trading Big Moves with Options

Market Measures

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Tom talks through the theory of market randomness and how historical price action does not really factor in to how tastytraders trade. That being said, is there any opportunity in selling what might be called “overstated fear” premium?

We look at historical occurrences in SPY and IWM when the stock rallied or sold off more than 2.5% in 5 trading days. If any of these “big moves” occurred, we looked at selling puts or calls depending on the direction of the move (selling puts into large drawdowns and calls into rallies). This study is viewed as implementing contrarian plats with options.

The results showed that selling puts into large down moves in these well-diversified ETFs was very profitable. This was probably due to the large premium that puts tend to exhibit during selloffs as people become afraid of a larger market drawdown. The call side showed mixed results as calls do not exhibit the same “fear” premium. Also, the market tends to drift upward in the long term, so this did not help the short call strategy either.

Tom talks through why we do not follow trends and why being a trend-follower is tough to profit from. He would rather step in front of a rally or selloff and make money as a contrarian fading outsized moves than by trying to follow trends.

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