Ok, let’s say that you have been researching XYZ stock for several weeks.  You like the stock, and are ready to get into it and then, all of the sudden, the implied volatility on the stock suddenly increases.  What should you do?

Let’s start by addressing the strategy we may be considering for this underlying.  The first choice we will discuss will be selling a cash secured put, and the second choice will be selling a levered put or a put credit spread.

If I’m selling a cash secured put, the news of a sudden implied volatility increase is something that I would always look at, but typically not act upon. 

The reason is that when I’m selling a cash secured put, it means that I would be happy to own the stock at the level that I sell the short strike price.  For example, if XYZ stock is trading at 55/share, and I want to sell the 50 put.  That would mean that I would want to own the stock at 50.  It would also mean that I would have $5,000 in my account earmarked for this trade.  If I want to own the stock, my time frame will be longer than 1 month (or whatever expiration you want to use).  So, if I have to deal with some more short term volatility in the stock, it won’t bother me.  My time frame is longer for owning the stock than the volatility in the option we are discussing.

In a levered put or put spread it is a different story.  The reason is that the short term options that you sell will match the sudden increase in implied volatility.  So, if there is a sudden increase in implied volatility, you will for sure have to be a part of it with your trade.  If you have the capital to hold onto a stock, you can weather the storm after the put is sold and you own the stock.  If you are levering yourself (not having all of the cash available to buy the stock), then you will need to exit the trade at some point soon and you might be on the losing end of it.  If you are fine with the risk, it is not a big deal.  If you are, then you need to not do this trade.

For more information on what I do in my financial practice, feel free to reach out to me at mtosaw@rcmfs.com.