Today I found out that the maximum number of legs per 1 order is 16. : options

In this post, I want to share a simple trade that I have on. This is a simple risk premium trade that should be quite profitable over the coming weeks.

For the last year, implied volatility for ASHR has been significantly higher than its realized volatility.

ASHR IV and RV

Because implied volatility is so high compared to realized vol in the past, we know that options have historically been overpriced. Options are implying breakeven prices so far apart that the stock doesn’t move enough to be profitable. We can sell these overpriced options.

Risk Premium

This trade can be described as a “risk premium” trade. There’s naturally a supply-demand imbalance in the options markets; nobody really wants to sell options (especially at size) because big market moves can blow them up. This leads to the tendency for options to be more expensive than they’re supposed to be. Interestingly though, the vol premium is much higher than something like SPY.

SPY IV & RV

I think the premium for ASHR is higher for several reasons:

• The underlying stocks in the ASHR trade in Shanghai – outside of US trading hours. If something happens overnight, traders (mostly market makers, probably) who are short options won’t be able to hedge until the morning. Traders see this risk and are less willing to sell these options at a good price.

• China could reimpose COVID lockdowns, which would be a potential market-moving event. This is a risk that only affects ASHR, not SPY. There are also geopolitical tensions (Taiwan) etc.

These are real risks, but seeing that realized volatility is rarely above 20% in the past year, it’s likely that these risks are smaller than the reward. We can collect this extra risk premium by selling straddles or strangles in small size.

Expected profit

Opening IBKR’s option strategy lab, we can see our expected profit. Since ASHR closed a bit over 30, Let’s start with a conservative estimate:

If options are overpriced by 3 points (IV is 21, realized volatility is 18), then our expected profit by selling a 30 straddle expiring in October is about $60 per straddle. Margin requirements are $1400. That’s a bit over 4% return on margin in under 40 days.

https://i.redd.it/wtkygaqs2nn91.png

Using a more aggressive estimate of 5 points (Iv 21, RV 16), our expected profit is just over $110 per strangle. The returns look pretty attractive on this trade.

https://i.redd.it/nsud9ng03nn91.png

Risk Management

Most of the risks we’re taking in this trade are the reasons we get paid, so there’s not too much to hedge. We want to make this trade in small size in case of volatility spikes such as the one in May.

We might want to hedge our directional exposure; if ASHR trends away from our strikes, we can buy or sell shares of stock to manage our deltas.

Let me know your thoughts in the comments, as well as any other trade ideas that you might have!