Capitalizing on Low Volatility

In the world of structured notes and option strategies, the prevailing belief is that low volatility equates to fewer opportunities. However, this couldn't be further from the truth. By constantly scanning listed options, we can gauge market conditions and determine the best structured notes to deploy.  There is always an opportunity if you know where to look.  In this post, we'll explore which structures actually price better during periods of low volatility.  

Listed option call spreads give the exact same payoffs as a Capped Growth note.  In the world of structured notes the name of the game is to maximize how much upside you can receive on these trades at any point in time - a trade with the same underlier and tenor that allows you to capture 50% of the upside is far superior to one which allows you to capture 40%. 

So what is it that determines how much upside a note can actually capture?  Let's examine… 

Explanation of the Analysis:

To demonstrate, we modeled options prices assuming the SPY was trading at $500. We analyzed the prices of several SPY call spreads with a 3-year expiration, varying both the strike prices and the implied volatilities (15%, 20%, and 25%).

A call spread involves buying a call option at a lower strike price and selling another call option at a higher strike price. This strategy caps the potential profit but also reduces the initial cost compared to buying a single call option outright. The lower the cost of the spread the better for returns

Below is a table showing different call spread strikes and the price of the spreads in times of lower and higher volatility. The call spreads start by giving 20% upside from the current price of $500 (SPY goes from 500 to 600) and end at 50% upside (SPY goes from 500 to 750).

Results:

For the 20% and 30% upside structures the difference between volatility periods is very negligible. In times when volatility is 15% and in times where volatility is 25% the cost between these spreads is under .5% of the SPY price.  

However, look further down the chart to the 50% upside spread. The difference between spreads is quite meaningful here at almost 2% of the SPY price.    A further look at the chart shows that the cost for 50% upside when volatility is at 15% is less than 40% upside when volatility is at 25%. That is a massive difference in potential returns returns

It's actually CHEAPER to put on a capped growth note that captures 50% of the upside when volatility is low compared to when volatility is high.

Conclusion:

Many advisors and practitioners believe that when volatility is low, there are no interesting opportunities in structured notes. However, the reality is quite the opposite. Our analysis demonstrates that certain structures are not only viable but also potentially more cost-effective during periods of low volatility. This contradicts the common belief that low volatility environments lack lucrative opportunities. 

There are always opportunities if you understand how to leverage the tools available. For personalized advice or more information, contact us today. 

Need Expert Analysis?  Forward any note to askus@marinelayeradvisors.com for instant review