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Don Kaufman here. |
I'm hungry. I'm hungry to trade right now. |
That's where I am this morning – coming in really light on trades after last week's volatility circus. Part of me is glad I didn't have a lot of positions going into Friday's chaos, but now I'm sitting here with cash burning a hole in my pocket and a marketplace that's actively trying to kill spread traders. |
Here's the brutal reality: SKEW is all the way back up to 159. You can count on two hands the number of times we've hit skew at these levels. |
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And when skew gets this insane, it fundamentally changes how you hunt for trades. |
When the Market Forces Your Hand |
Good luck. You have no shot at an in-out call spread that's gonna be reasonably priced unless there's some crazy inverted implied volatility skew. |
I'm not being dramatic here – I'm showing you the math. Look at any major name right now. |
Take Apple as an example. If I wanted to get bullish (which I don't, but stay with me), the cost of a call spread versus a put spread is astronomical. |
You're basically forced to either look for bearish trades or find something with inverted skew. |
You know where I found inverted skew? GLD. |
Let me explain what that means for those of you who haven't dealt with this before. |
Most of the time in equities, you see what we call negative skew - the puts are more expensive than the calls because everyone's willing to pay up for downside protection. |
Makes sense, right? People are scared of losing money, so they bid up the puts. |
But inverted skew flips that whole thing around. |
Now the higher strike calls are more expensive relative to the lower strikes. You're seeing higher implied volatility in the upside options instead of the downside protection. |
This usually happens in commodities like gold, or when you've got strong upward momentum and people start willing to pay stupid money for upside exposure. Supply constraints, momentum chasers, whatever - they're bidding up those calls. |
That's why the GLD trade worked - it negates the skew. I'm buying something in the 14 vol handle and selling something in the 15 handle. Not bad, right? The skew is actually working in my favor instead of against me like it is everywhere else right now. |
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Shopping the Usual Suspects |
When I'm hunting spreads, I don't really trade much outside my list ever. |
I'm going down my usual suspects: the ETFs, the big names, the stuff I know inside and out. But right now? I'm finding myself pushed toward sector ETFs that nobody seems to like anymore. |
XLI, XLY, XLB – these went from some of the most beloved sector ETFs to complete afterthoughts. |
They're hitting expected moves, breaching expected moves. Any one of these could be a great "bounce and fade" trade. Huge sell-off, ripping bounce, maybe more selling coming. |
But here's where discipline kicks in. XHB – the home builders – has had virtually no options activity lately. Just the big donut. No volume means I'm not touching it, no matter how good the setup looks. |
The 30% Rule (And Why It's Sacred) |
In in/out spreads – and ONLY in in/out spreads – I use a 30% profit target after three days, then we're out. That's it. |
I've had people ask me about applying this to other strategies. "I was up 30% on this butterfly..." Stop right there. 30% on a butterfly? You got nothing. You paid 30 cents, made 10 cents, congratulations. Butterflies need 150-200% gains to be worth your time. |
The criteria for one strategy doesn't necessarily permeate to other strategies. |
Some shared logic? Sure. But each trade type has its own rules for a reason. |
Do More of What Works |
Here's something most traders never do: I actually look at my P&L by individual products. Find out what you're good at and what you're not good at. Then do more of what works and less of what doesn't. |
My hated product this year? Meta. Haven't done well in it, so you're not gonna see me placing a bunch of in/out spreads there. It's just reality. Move away from what's not working. |
What works for me? A lot of the ETF products. Gold has been really good this year. Silver too. But XLU? We've gone back and forth over the years. Maybe it's more favorable for me right now, but I hate having to bear up in there. |
When Volatility Sees Something You Don't |
Here's what's got my attention today: volatility futures are way up while the S&P is only down a few handles. Those two don't jive. That's anticipatory of more risk compiling. |
The marketplace clearly has the ability to make substantial moves in short periods under limited liquidity. That's not great. So if you're gonna get bullish right now, use call ratio back spreads. Take advantage of the skew wherever you possibly can. |
I'm shopping. I'm hungry. |
But I'm also being smart about it. In this environment, that might be the difference between eating well and getting eaten alive. |
Which is why it's so important you pay attention to implied volatility amongst products and across strikes. |
In addition, you have to look at order flow right now. Is money moving in? If so, in which direction? |
Tomorrow I'm breaking down order flow secrets that most traders never see. The stuff that tells you where the smart money is really moving. |
====> RSVP HERE |
To your success, |
Don Kaufman |
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