When IV Drops, Options Lose Their Value

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IV: In tonight's video, we're going to go over all of the trades that we made for Wednesday, February 18th. Before I do, I just wanted to alert you to some new stuff that we're doing. We're always working, or I'm always working on this platform making it better, and better, and better for you guys. A lot of the comments that we had with the answer vault was that you guys wanted to make everything clickable and link-able as far as hot links.

What we are doing, and I've only done 3. You can see there's only 3 of them in here right now. What we've done inside the answer vault, because this is a massive, massive bank of Q & A over the last 8 years. I've taken so many questions. I don't even know how many questions are in here, 70, 80 questions that are in here and listed them all out with detailed answers to each.

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What we're going to do is create these hot links that are inside the answer vault. You'll start to see these start to accumulate over the next couple of days. You'll start to see these hot links so you can quickly just click on any of these links to answer that question. If you wanted to know what's the best strategy for an earnings trade, you basically click that and it goes right down to where that answer is inside of the whole answer vault.

You can easily just click right back to the top. It makes it very easy, very searchable for you guys as far as finding the right answers. Again, hopefully that helps out. As always, if you guys have questions on the platform, or if there's something that you see that we can add, please let me know. It's built for you guys to make it easier for you.

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As far as trades go today, we had a pretty light day as far as trading goes. We did enter 2 new earnings trades, 1 in Solar City and 1 in Walmart. Both of those are looking pretty good. Solar City's definitely looking good after they announced earnings. We had some closing trades in FXI, closed out trade in FXI and then had basically a closing hedge in XLE before expiration. Let's actually cover the earnings trades.

We're going to start with Solar City because I've already got a lot of questions about these. This one is definitely a small trade. All of our earnings trades are small trades. You'll probably notice that going back through some of the video tutorials. If you're new to premium membership this week, go back through some of these videos right here inside the watch list area.

Again, you can just do that very easily by clicking on this playlist button right below. You can see all the videos that we've done going back in time. Right now, with Solar City, it was a really good trade. We did a trade that was just outside of the expected move. We did the 63 call, the 52 put. We took in about $1 credit for the strangle on Solar City.

This is the second time that we've traded this stock through earnings, traded it last time in the last quarter, did really well with it. It was very favorable for us, so we went back to the well here and tried to trade it again. We did do the February contracts. These are the February monthlies. I got a lot of questions from people saying, "Kirk, well why don't you trade the weeklies?"

In this case, since February expires this week, these February traditional monthly contracts, they act as the weekly contract going forward. In this case, these Februaries are going to be our weeklies. That's why we traded them. There's no weekly tag here. It is truly the February contracts. When you actually go to the trade tab here on Think or Swim with Solar City, you can see that the expected move, up in the top right hand corner, was about $4.23.

We always round up from there and say, "It's about a $5 move from where the stock was trading." The stock closed at about 57. With our strike prices at 52 and then all the way up above at 63, which we can't even see right now because the stock's already made a move after earnings, that put us basically at a $5 move with our strike prices, so right on the boundary of that expected move that the stock could have.

We also were able to take in a $1 credit, or a little over a $1 credit on the trade, 1.02. That moves our break even point out to about 64 on the top side and down to about 51 on the bottom side should the stock make a move just beyond that expected range. That's why we like this trade. We took in a credit there.

As far as pricing goes and then volatility, a lot of people ask, "Implied volatility on this particular trade did have low implied volatility." I definitely recognize that. I know that that's not the norm of what we like to do. We love to see that implied volatility much, much higher. It definitely does have a nice selloff in volatility, or a mini IV crush every time that it has earnings. That's really what we're playing here, is this implied volatility crush.

Again, just doing a little bit of research on it looking back, historically, the stock doesn't make that many gaps. There's probably very few gaps in here around earnings. It's not like a Netflix, or an Amazon that is going to open here and then gap much, much higher. It's going to make a little bit of a move for sure, but it's not going to make a 50, 20, $30 gap higher. That's just historically how it's been.

After hours, right now, the way that the stock sits right now, it's trading right now after hours, after announcing earnings at about 54.29, just above 54. You can see our break even price on the bottom side's about 51. It's definitely heading that direction, but it looks like all things stay the same tomorrow when the stock opens. We should have a really nice profit again in Solar City, so ended up being a fairly decent trade.

The other trade that we got into today, as far as earnings are concerned, is Walmart. We were able to trade Walmart, did a strangle in Walmart could be 88.84 strangle. We sold the 88 calls above the market, sold the 84 puts below the market. Took in about a $.71 credit. Again, that $.71 moves our break even point out just a little bit further in Walmart.

Walmart did have really high implied volatility heading into this earning, so it should be really nice to see a good drop in implied volatility once they announce. I believe they announce actually tomorrow morning is when Walmart announces. Right now, our strategy is .... Or, maybe they already did announce. Maybe they did announce after hours. No, I don't think they did.

Right now, our strategy is on the edge on either end. We definitely tilted it just a little bit higher from where the stock was earlier today. We tried to go to about the 15% probability on either side, but you can see the stock's moved and expanded. It was a little bit more volatile heading into the day, into the close here today. It should be a pretty good trade.

I'm definitely expecting the stock to stay within that $2 range that we originally had when the stock closed. We're right on the edge here, but we've got a pretty good distance on either side with our break even points. I like the trade. Again it's a small trade in Walmart. We had originally hedged ourselves just a little bit to the top side. I think maybe even they might have announced earnings. I don't know if it was tonight, or tomorrow, but its stocks trading a little bit higher towards the top side of our range right now.

Those are the only 2 earnings trades that we had, both of them small. We should do pretty well on them. All right. Closing trade-wise, we were able to close out of our FXI position, our Iron Condor for March. FXI's been really, really favorable for us for the last basically 2 months. Our February position should be a full winner. This FXI for March, we closed it out at more that 50% of our max profit, bought it back for $.11 debit.

At this point we've made $38 on the trade. It's not worth holding it for another $22. At this point, we can only make $.11. We've only got 2 of these Condors. We're basically holding this thing for another 30 days plus to make $22 when we've already made 50% plus of what we could potentially make on this trade. It just really doesn't make sense to do that.

As far as FXI is concerned, implied volatility-wise, what you'll see is that actually we did have a nice drop in implied volatility, which is really what we expected. We had been trading FXI when it had really high implied volatility. Now that implied volatility is starting to come down, even with the stock trading basically sideways, that's why we're starting to see really quick decay in these options. That's where our profit is materializes.

Implied volatility has really neutralized. It's come back down. It's become more cyclical. That's really, again, what helps this position mature into a profit. All right. The one closing adjusting trade that we had was in XLE. This wasn't really a hedge, but much more of just basically legging out of our Iron Condor and XLE. This was the call spread side, the 81/82 call spread that was in the money.

We exited this for about $.55 in debit. If we held this thing all the way to expiration, then this thing would actually turn into a $1 debit by Friday. We're basically getting out with about half of the max loss, which to me is really good. Right now XLE is trading above that level. It's definitely going to materialize into a losing trade by that point. We just wanted to make sure that we keep that trade on. Obviously, we have our remaining position in XLE that should be okay. The put spread should be okay, well below the market at this point for the next 2 days.

We'll just leave that put spread on. Let that put spread expire worthless at this point and see what happens. At the time that we actually exit that trade today, it was really far in the money. XLE's come back down just a little bit and maybe is a little bit of dumb timing and luck with where the market ended up today.

The resulting position is going to be okay. We'll lose a little bit of money on XLE, but not too much. It's a very small position, as always. If you guys have any questions, please add them right below to the video and to the trading page. Until next time, happy trading.

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and two daughters.