🎓 Topic of the Week: Three Trades Using High-Probability Options Strategies in Today's Volatile Market

The volatility in today’s financial markets is off the charts. From geopolitical tensions to central bank moves and inflation fears, market sentiment has led to increased implied volatility (IV) in major indices and individual stocks. This presents a unique opportunity for options traders to profit from inflated premiums. In this deep-dive, we’ll explore three high-probability options strategies — bull put spreads, wide iron condors, and deep out-of-the-money naked puts — that are particularly effective in these turbulent times.

Check out the IV rank of several major ETFs below. The chart, courtesy of Slope of Hope, highlights the current surge in volatility, which is pushing up options premiums across the board. Typically, SPY and other highly liquid ETFs hover between the 25-35 range, but as shown, with the exception of BITO, all the ETFs are above 50. This indicates that volatility is heightened and options selling strategies are the preferred approach in this market environment.

Each strategy below offers a distinct approach to capturing premium in a volatile market while controlling risk. Let’s dive into each strategy/trade in detail.

1. Bull Put Spreads: Selling Fear with Defined Risk

Strategy Overview:

In a bull put spread, you’re using two put options to create a position with limited risk and the potential to make a profit. The idea behind it is simple: you sell one put option at a specific price (called the strike price) and buy another put option at a lower strike price. Both options have the same expiration date, meaning they will expire on the same day.

Here’s the step-by-step process:

1. Sell a Put Option (Higher Strike): You sell a put option with a higher strike price. By selling this option, you receive a premium (the price paid for the option). The reason you're selling is that you believe the price of the underlying asset will not fall below this strike price by the option's expiration.

2. Buy a Put Option (Lower Strike): You buy a put option at a lower strike price. This option will cost you a premium, but it acts as a form of insurance. It limits your potential losses if the market moves against you. The reason you buy the lower strike option is to protect yourself from unlimited risk, which is a common concern when selling options without a hedge.

3. Both Options Expire on the Same Date: Both options have the same expiration date, meaning you’ll know exactly when the strategy ends and whether you’ve made a profit or incurred a loss.

Why It Works in High IV:

When market volatility increases, the price of put options generally rises. This happens because more people seek to buy puts for protection during times of uncertainty. By selling puts, you can capitalize on these inflated premiums. The bull put spread benefits from high IV, as the premiums on options tend to be much richer. The downside is limited because of the protective nature of the long put, so your maximum potential loss is capped, making this strategy particularly appealing during volatile periods.

Example Setup:

Let’s take the S&P 500 ETF (SPY) as an example. Currently, SPY is trading for $533.94. The market has recently seen a sharp decline, leading to a significant spike in implied volatility. This has resulted in an IV rank of 66.7 and an IV percentile of 99.9. With an expected move of ±41, the anticipated price range for SPY over the next 33 days is roughly between $493 and $575. Let’s place a high-probability bull put spread just below the expected range with a probability of success around 75%.

• Sell to open a 490 strike put

• Buy to open a 485 strike put

• The net credit received (the premium you collect) is $0.80, for a potential max return of 19.0%

• The probability of success on the trade is 75%.

Max Risk: The maximum loss occurs if the stock falls below $485 at expiration. The risk is calculated as the difference between the two strike prices, minus the premium received. In this case, the difference between $490 and $485 is $5.00, and after subtracting the $0.80 premium received, the risk is $4.20 per contract. This translates to a total of $420 per contract.

Max Profit: The maximum profit is the premium received for selling the spread, which in this case is $0.80 per contract, or $80 per contract. This profit occurs if the stock stays above $490 at expiration.

Breakeven: The breakeven price is $489.20, which is the short put strike price ($490) minus the premium received ($0.80). This represents a price that is 8.4% below the current price of SPY.

Management Tips: When managing a bull put spread, I generally look to take off half of the trade once I’ve captured 50% to 75% of the premium, or $0.20 to $0.40. This allows me to lock in profits on part of the position while still keeping some exposure to the trade in case the market continues to move in my favor. Letting the other half ride gives me the potential to capture additional gains without committing all my capital.

If the trade starts moving against me, I look to exit the position if the loss reaches 1 to 2 times the original net credit I received. For example, if my net credit was $0.80, I would consider exiting if the loss reaches around $1.60 to $2.40 per contract.

2. Wide Iron Condors: Harvesting Premium from Both Sides of the Storm

Strategy Overview:

A wide iron condor is a neutral options strategy that involves selling both an out-of-the-money call and put, while simultaneously buying further out-of-the-money call and put options for protection. The goal is to profit if the underlying asset remains within a certain range through expiration. The key difference between a traditional iron condor and a wide iron condor is the distance between the strike prices — in the latter, you set the short strikes farther apart to allow for more movement in the underlying asset.

Why It Works in High IV:

In volatile markets, both calls and puts have inflated premiums due to the heightened demand for protection. The wide iron condor takes advantage of this by selling premium on both sides of the market — both puts and calls — and collecting a larger premium. The "wide" nature of the strategy provides a larger margin of error, meaning the underlying can move significantly before causing a loss. The key to success with this strategy is the market staying within a broad range, which often happens after a panic sell-off.

Example Setup:

If the S&P Biotech ETF (XBI) is currently trading at $74.30, and implied volatility is elevated, you could set up a wide iron condor with the following strikes:

• Sell a 55 put and an 85 call

• Buy a 90 put and a 50 call for protection.

This setup creates a 30-point range between 55 and 85, where you can profit if the S&P stays within that range by expiration.

The probability of success is 84% to the upside and 92% to the downside.

Risk and Reward:

• Max Risk: The maximum loss occurs if the price moves beyond your long options (the 50 put or the 90 call). In this case, the risk is the difference between the short and long strikes (30 points), minus the premium you collected, or $0.80. Potential max loss $4.20.

• Max Profit: The maximum profit is the premium received when selling the iron condor. For example, you might collect $0.80 per share (or $80 per contract), for a potential max return of 19.0% over 33 days if the market stays within my chosen 30 point range.

Management Tips:

• Monitor both sides of the condor closely. If the stock begins moving toward one of your short strikes, it’s critical to adjust the position to minimize risk.

• If one side of the condor is approaching the strike price, you can close that side and keep the profitable side open, or roll the position to reduce risk.

• As the volatility shrinks after a spike, premiums start to decay. You can often close the trade early for 50%-80% of the max profit.

3. Deep Out-of-the-Money Naked Puts: Cashing In on Panic (with Caution) While Building Portfolio Positions

Strategy Overview:

Selling deep out-of-the-money (OTM) naked puts involves selling put options with strike prices well below the current market price. While this strategy involves significant risk if the market drops sharply, it allows you to collect premium in exchange for the obligation to buy the underlying asset at the strike price, should the options be exercised. We covered this strategy in depth in last week’s issue.

Why It Works in High IV:

In high-volatility markets, even deeply out-of-the-money puts become significantly more expensive as investors rush to buy protection. If you believe the market has overreacted and a specific stock or ETF isn’t likely to drop that far, you can sell these deep OTM puts and collect the premium. The key trade-off is that you must be ready to purchase the underlying asset at the strike price if the market drops considerably. Therefore, selling puts when implied volatility is high (and likely overbought) presents an excellent opportunity to initiate a Wheel Strategy or to add long-term positions you’d like to own at a discounted price.

Example Setup:

If Nvidia (NVDA) is trading at $110.93 and you're comfortable owning it at $95, you could sell a $95 put in a volatile market. If the premium for the $95 put is $2.75, you'd collect $275 per contract, which represents an upfront return of 2.9%. The IV rank is 60.3, with an IV percentile of 89.8. The expected move is ±13.44, putting the expected price range between $97.50 and $124.37. If assigned, you'd end up owning NVDA shares at an effective cost of $92.25, which is 16.8% below the current market price. The probability of success on the trade is 75%.

Risk and Reward:

• Max Risk: The maximum risk occurs if the stock falls to zero. Your risk is the strike price minus the premium received, which in this case is $92.25 per share ($95 - $2.75).

• Max Profit: The maximum profit is the premium collected, which is $2.75 per share, or $275 per contract. This represents a return of 2.9% over 33 days, provided the stock remains above $95.

Management Tips:

• Always make sure you have enough cash set aside to purchase the stock at the strike price if you're assigned the position.

• If the stock starts moving toward your strike price, you can roll the put to a later expiration or a lower strike to give the stock more time to recover.

• Keep an eye on the stock’s fundamentals to ensure you’re comfortable owning it. This strategy works best when you believe the stock is undervalued or when it’s part of a strong index or sector.

• If you are assigned the shares, remember you’re buying them at 16.8% less than their current market price.

• Each time you sell puts, you have the opportunity to reduce your cost basis further.

• You can also turn this strategy into a Wheel Strategy, allowing you to continually generate income while building a position.

Conclusion: Navigating Volatility with Precision

High volatility can be a daunting market environment, but with the right strategies, it offers incredible opportunities for profit. Bull put spreads, wide iron condors, and deep OTM naked puts each provide a way to capitalize on inflated premiums while managing risk effectively. These strategies can help you profit from market fear, whether you expect stabilization or a continued move within a defined range.

In the current volatile market, it’s crucial to implement these strategies with precision, discipline, and the right risk management approach. By carefully selecting your positions and continuously monitoring the market, you can harness volatility to generate consistent profits with high probability trades.

Probabilities over predictions,

Andy Crowder

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