Covered Calls for Fun & Income

May 6, 2009

Volatility – HV vs IV

Have you been watching CROX? My gosh! It’s on fire! I entered this on 4/28 and paid 2.21 for the stock and sold the MAY 2.00 Call for 0.41. As of this moment, the stock is at 3.89, a 76% increase! Thinking that I should close this early, as I have in the past when other stocks made similar moves, I ran the numbers. To my surprise, it didn’t work out well at all. I would have to buy back the Call for 2.01 for a net debit of 1.60 and sell the stock for a net gain of 1.68 – I would only make 8¢! Why?

A closer look reveal the Bid/Ask spread on the MAY 2.00 Call is 1.60/2.01 – a rather large spread which was not there when I entered this Buy-Write (I wish I had recorded the actual numbers). But the most obvious indicator is the Implied Volatility (I have posted about this in the past – see April 18th post).

Remember, I want to stay away from Covered Calls that have a Historic Volatility on the stock that is less than the Implied Volatility on the option I am targeting. In this case, as of this writing, the stock HV is 175% (high enough as it is) and the MAY 2 Call is 421% – well over double the HV! That’s why I can’t close this early.

If we express the HV/IV relationship as a ratio, in this case we would get 1:2.4 – definitely a trade I would pass on if I were to do it today. I look for ratios of less than 1:1, more something like 1:0.75 (where HV=120 and IV=90 for example).

When I am looking to enter a trade, one of my several stops on the CallWriter Research Page is the H. Volatility link. Here I can quickly compare the 10, 20 & 30 day Historical Volatility and the Implied Volatility of the near the money options. If they are out of line (greater than 1:1) the potential trade is rejected immediately.

– Jeff

“I have opinions of my own — strong opinions — but I don’t always agree with them.” George Bush (1924 – )

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1 Comment »

  1. Jeff,

    I’d like to read more about why you avoid selling covered calls when the HV is less than the IV. Personally, I would normally prefer to sell options when the IV is higher than the HV.

    Jeff P.

    P.S. Would you consider posting something about your reason(s) on justcoveredcalls? I think it would generate some comments/feedback on this question.

    Comment by Jeff — May 6, 2009 @ 11:59 PM


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