The Inverse Skew on Gold

Implied volatility is the measure of the volatility of the price of a security. It increases when the market is bearish (when things are going down) and decreases when the market is bullish.

When things are going better (up market) people are less nervous (down volatility). But when there is tumultuous economy, the VIX will spike in response to the fear of the consumer.

The VIX is sitting around 10.13 right now, which is only pennies higher than the yearly low of 9.37. We can look at this number and postulate that there isn’t a lot of fear in the marketplace right now.

We can also look at gold and see the positive correlation to implied volatility. When IV moves up, Gold moves up.

Gold exhibits an inverse skew in the options, wherein call options trade richer than puts, and put spreads trade richer than call spreads. You can sell a call for $1.50 credit, and short a $2 wide put spread with $0.50 of credit, and shoot for a total credit of greater than $2, we have a reverse lizard.

When we manage trades at 25%, we can have a higher success rate and a higher P/L simply because we spend less time in the trade, and thus reduce our overall risk. When we manage this reverse lizard in Gold at 25%, we can expect to have a 90% success rate, and spend about 16 days in the trade. But, our average PL is -$12, despite this very high win rate.

So we only get into Gold when implied volatility is low. But we have to be pretty aggressive in the trade in order to make any money.

So when we look at this trade again with high IV > 50, we have an average PL of $41.72 with a success rate of 93.9% at a 25% management rate. That’s incredible!!

High IV is the key to trading success. We make $50 more on our reverse lizard just by having an IV > 50. And if we manage at 50%, we have a 90% success rate and an average profit of $68.56.

Sounds pretty good to me!

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.