That is, of course, market-dependent. Options on stock indicies do increase in IV as the market falls. Coffee, on the other hand, increases in IV as the market rises. I only mention this distinction to drive the point home--IV is the way the market factors out directional risk. If Coffee is going up, it could go up A LOT--if Coffee is going down, it's most likely not going to go down a lot. So, when the market moves in the direction that's more risky, IV goes up. That doesn't mean a move is priced in, or that calls become cheaper than puts, it just means the risk premium is higher.
Yucca, You don't need a PhD in maths or to even read Cottle's book to understand the basics of option pricing. In order to understand that option prices imply only a range and not direction all you need to understand is the Put-Call Parity. Here's a quick summary of the put-call parity. The put-call parity states that a call and a put on the same underlying and with the same strike price and expiration must trade at the same Implied Volatility otherwise there's a riskless arbitrage opportunity. Let's suppose that there is a general consensus that a certain stock is going up. People would buy calls and thus bid up the implied volatility as all the other factors are still the same (i.e. time to expiry, stock price and etc.) This would make calls overpriced relative to puts, arbitrageurs would step in and start buying puts and selling calls to take advantage of this opportunity, they would do so until the puts and calls get back in line, i.e. trade at the same implied volatility level. Consequently, option pricing does NOT imply direction, it does imply a range of prices though.
Taken over a range of strikes, option vol skew CAN imply direction. Specifically the likelihood of a spike up or down. There has been considerable discussion of this in the literature. Here is just one reference: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=874991 .
This post is not seeking further dialog, but simply a report on how well a DITM vertical bull call spread portfolio fared after the past week. This analysis was figured about midday today, mar 5. This portfolio has 299 spreads in fifty different stocks and ETFs. 208 spreads are still DTM - 69.6% 65 spreads are still all ITM - 21.7% 26 spreads are now ATM - 8.7% note: DITM is loosely short calls are 10% deep or at least 1 full spread level deep. (long calls obviously DITM) ITM is short calls are still ITM. (long calls DITM) ATM is long call is now ITM, short call is OTM note: not all of the spreads were DITM on Monday Feb 26. I don't have stats, but at least 10% of the spreads were ITM at that point. I also had 7 spreads that were ATM at that point. 95% of these spreads expire in June or later. How will it look next week? Don't know.
Wow, I see the last post on this thread is just about 5 years old! Whatever happened to some of the participants in this thread? Yucca still doing DITM spreads? If so, at 50% per year, he is no doubt wealthy beyond belief. Anybody else still here from this thread who can share what they have learned in 5 years about this?
Just read the thread. Still don't understand why everyone beat up the opening poster. It's a hell of a good strategy, especially when combined with solid stocks, good fundamental analysis, and diversified across different sectors.. I personally tend to leg into spreads that are DITM. For example, on a huge up day or when the markets are up 7 days in a row, I will sell to open a DITM call...on a market pullback , I will then purchase a DITM call, completing my spread... As an example of my latest spread, with aapl this week soaring once again, on Thursday sold a Jan 2013 $505 call for around $116 and change.. On Friday, I bought the Jan 2013 $495 call for around 117.40 Net:I paid $100 for a spread that can be worth up to $1000. DITM options spreads are good..but I disagree with the opening poster in terms of trade setup..I'd rather leg into a spread and buy it for real cheap, then spend $400 with the intention of selling it for $500... (I can already hear everyone yelling " yeah yeah, u can't always time it right..a few screwups in timing the legging and it will kill the portfolio..." Here is my response: Legging will still be more profitable in the long run for the following reasons: my spreads give me a much higher payout . Second, once entered, they cost a heck of a lot less than entering a spread at once, and thirdly,EVEN IF U SCREW UP THE TIMING OF ENTERING THE SPREAD, U have TIME to correct it..)
Thanks Adam. Yes, I had read the entire thread, and wondered why it came to a screeching halt 5 years ago. I appreciate your strategy below. I do something similar with selling strangles, adding the purchased option when the market moves away from a particular strike. Much better than an Iron Condor in my opinion.
And he also stopped visiting ET after March 2011. My non professional guess is he didn't survive the 2008-09 crash and a bad 2011. On the other hand @El OchoCinco who cautioned yucca is still here posting.