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Consistent income trading options: Low IV and rallies

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In our quest to understand trading options for income, we often consider buying Calls when a rally occurs and there is low IV (implied volatility).. Does this strategy of buying a Call option actually work when we are in the midst of a rally?

A long Call is simply buying an ATM (at the money) option (where the Delta is 0.50) with the expectation that the underlying will continue its rally; you could buy an OTM (out of the money) Call option for less cost, but the Delta of the option will be smaller (less than 0.50). Delta indicates how the option price will move for each $1 of movement of the underlying. For example, if the underlying increases in price by $1, an ATM option with a delta of 0.50 will theoretically increase $0.50 ($1 x 0.50 delta).

To determine if an ATM long Call strategy during a rally works, Tasty Trade recently conducted a test over five years of the following ETFs: AAPL, AMZN, and BIDU. The test criteria was as follows: enter a Long Call trade if the underlying ETF advances more than 10 percent within a two-week period. In addition (for comparison), enter the following bearish trades: short Call at 69 percent OTM; short Call at 84 percent OTM; and a Call credit spread receiving premium at one-third the width of the strikes.

It is assumed that all positions were with the front-Monthly and held to expiration.

The results: in each underlying, there was a substantial P&L loss for the ATM long Call; the 84 percent short Call was positive for all underlyings while the 69 percent short Call and the Call credit spread were positive for AAPL and AMZN, and negative for BIDU. The highest percent winner was AMZN with the 84 percent short Call.

In conclusion, even during rallies the ATM long Call did not work. It is worth noting that the further OTM 84 percent position had the highest percent winners than the other strategies. It would be interesting to see the results if the position was managed at 25 and 50 percent profit levels. One last point, BIDU is apparently a very risky stock to trade both short and long.

If you would like to learn more about options, and how to generate consistent weekly income trading options, go to Options Annex.

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