I have always given high importance to the role of volatility in factoring option trades. I used to be a mean reverting option seller wherein even I would try to catch the top. Even if the stock doesn’t reverse or simply consolidated, I would make money since volatility will crash. I have barely traded the opposite scenario wherein volatility is bare minimum.
Volatility is cyclical in nature. If it is compressed now, it will blast later. But timing of that blast is quite an unknown aspect. If volatility is dead, it can stay dead for a long time or it might only give a dead cat bounce. Therefore, remaining scared of that volatility blast can give a wrong impression about current state of market.
And this is what happened to me last week. I took nifty index 50 strangles which were far far OTM than they should have been. Selling such options are safe but then one can park money in FD for this much safety. The notional loss of last week is huge. Had I sold options at appropriate distance last Thursday, I would have made good money by Tuesday. But fear got the better of me.
On the contrary, since I did not make expected money by Wednesday, I started doing just the opposite. I sold strikes which were near to money, just for the sake of reaching CAGR of 35%. While my objective is simply to beat CAGR of 15% or Nifty’s return, whichever is higher, I have been tasting 35% or more and did not want to slip. And thus greed got the better of me.
Fear and greed…greed and fear…market is a function of simply these 2 emotions. Price and volatility are nothing but a reflection of these emotions. Despite knowing it all, I made mistakes. I always do. The market forgave me this time. And I better pay my respects and learn.
The simple learning is this. I have a strike calculator. It is indigenously built and is proprietary stuff, I suppose. Since it is self-created, I do not believe much in it. I did not take the strikes which calculator was advising and made a mess of the week. Another learning is that I should also try to observe volatility behavior when it is low.
Important takeaways. I hope I remain committed to them.