I have been asking ChatGPT questions about options trading to help me on my odyssey to become a professional options trader.
And I have to say I have been pleasantly impressed by ChatGPT’s capabilities. And this of course is a total understatement. Try it out yourself: go to OpenAI and subscribe to ChatGPT.
Here are some of the more difficult options trading questions I asked ChatGPT.
Table of Contents
Volatility Skew Questions
My question: Why is declining market volatility key to a successful iron condor.
ChatGPT: A successful iron condor strategy depends on declining market volatility because the option premiums received from selling the call and put options are more valuable when the market is less volatile. In a declining volatility environment, the options’ implied volatility falls, and their premiums decrease, which can increase the profitability of the iron condor. In a rising volatility environment, the options’ premiums increase, which can lead to a loss for the iron condor trader. So, declining market volatility is key to a successful iron condor because it can provide a favorable environment for the option premiums to decrease, which can increase the strategy’s potential for profit.
My question: What is the options skew curve?
ChatGPT: The options skew curve is a graphical representation of the implied volatility of options with different strikes. It shows how the implied volatility changes as the strike price changes for a specific underlying security. The options skew curve is typically plotted on a two-dimensional graph with the implied volatility on the y-axis and the strike price on the x-axis. The curve shows how the implied volatility changes across different strike prices and provides insight into the shape of the volatility surface.
Options skew is usually classified into three types: negative skew, neutral skew, and positive skew. Negative skew occurs when options with lower strike prices have higher implied volatility than options with higher strike prices. Neutral skew occurs when the implied volatility is uniform across different strike prices. Positive skew occurs when options with higher strike prices have higher implied volatility than options with lower strike prices.
The options skew curve is important for option traders because it can provide insight into market expectations for future volatility. Understanding the shape of the skew curve can also help traders make more informed decisions about which options to trade and how to manage their positions.
I then took it one step further and wanted to know which tools I should be using to determine skew. Is ChatGPT really going to be a great help when trading?
My question: What tool to plot options skew?
ChatGPT: There are several tools available to plot options skew, including:
- Trading platforms: Many online trading platforms offer tools to plot options skew, including Thinkorswim, Interactive Brokers, and TD Ameritrade. These tools can provide real-time data on implied volatility and options prices, allowing traders to visualize the options skew curve.
- Spreadsheet software: Options traders can also plot options skew using spreadsheet software like Microsoft Excel or Google Sheets. This requires manual data entry and calculations, but can be a cost-effective way to visualize options skew.
- Custom software: Some traders and financial institutions may choose to develop custom software to plot options skew. This can provide a higher degree of customization and control, but may require more time and resources to develop.
Regardless of the tool used, plotting options skew can provide valuable insight into market expectations for future volatility and help traders make more informed decisions about which options to trade and how to manage their positions.
I needed to know more and asked about the following.
My question: Does negative skew mean bearish direction?
ChatGPT: A negative options skew does not necessarily indicate a bearish market direction. Rather, a negative skew refers to a distribution of implied volatilities for options with different strike prices in which options with lower strike prices have higher implied volatility than options with higher strike prices.
The direction of the market ( bullish or bearish) can influence the shape of the skew curve, but a negative skew by itself does not necessarily indicate a bearish market. The direction of the market is determined by a number of factors, including economic data, company earnings, geopolitical events, and market sentiment. The options skew curve provides information about the shape of the volatility surface and the distribution of implied volatilities, which can be useful for traders in making more informed decisions about options trading.
Then I had a question on rolling:
My question: If IV is low should I still roll credit spreads?
ChatGPT: The decision to roll a credit spread should not be based solely on Implied Volatility (IV) being low. There are several other factors to consider, such as the expiration date of the options, the strike prices, the credit received, and the underlying stock’s price movement. Additionally, rolling a spread involves closing an existing position and opening a new one, so it’s important to understand the implications of the trade and assess whether it aligns with your overall investment strategy. It’s always recommended to consult with a financial advisor or do thorough research before making any investment decisions.
And then I mistyped my question, but ChatGPT came to the rescue and finished my sentence! Very impressive!
My mistyped question: If IV is low ca n I
ChatGPT finished my sentence (!): make more money with credit spreads?
And answered it: The potential profit from a credit spread is determined by the credit received and the price movement of the underlying stock, not solely by the Implied Volatility (IV) being low. While lower IV can indicate lower option premiums, it also means that the expected price movement of the underlying stock is smaller, which can affect the profitability of the spread. Additionally, there are other factors to consider, such as the expiration date of the options and the strike prices, that can impact the potential profit from a credit spread. It’s always important to consider all relevant factors and do thorough research before making any investment decisions.
But this is what I meant to ask: If IV is low, can I still roll credit spreads?
ChatGPT replied: Yes, you can still roll credit spreads even if Implied Volatility (IV) is low. Rolling a spread involves closing an existing position and opening a new one, so the decision to roll should be based on a comprehensive evaluation of all relevant factors, including the expiration date of the options, the strike prices, the credit received, and the underlying stock’s price movement. Low IV may indicate lower option premiums, but it also means that the expected price movement of the underlying stock is smaller, which can affect the profitability of the spread. It’s recommended to consult with a financial advisor or do thorough research before making any investment decisions.
By now I was convinced ChatGPT is going to revolutionize trading and learning as we know it. I went on to ask about VIX.
My question: Explain on an IV spike in-the-money calls should appear underpriced, and when the VIX is oversold, calls should appear overpriced.
ChatGPT: The price of an options contract depends on multiple factors, including the underlying asset’s price, time to expiration, volatility, and interest rates.
When an IV (Implied Volatility) spike occurs, it suggests increased uncertainty and potential price swings in the underlying asset. This usually leads to higher options prices, as the market prices in a higher chance of the options being in-the-money (ITM) at expiration. Hence, when an IV spike occurs, ITM calls should appear underpriced, as the market has not yet fully adjusted to the higher implied volatility.
On the other hand, the VIX (CBOE Volatility Index) measures market participants’ expectations of volatility over the next 30 days. When the VIX is oversold, it suggests that the market is expecting lower volatility and fewer price swings. This usually leads to lower options prices, including calls. Hence, when the VIX is oversold, calls should appear overpriced as the market has priced in too low an expectation of future volatility.
My question: Why is buying VIX OTM calls in the middle of a crash one of the worst trades?
ChatGPT: Buying VIX Out-of-the-Money (OTM) calls during a market crash can be one of the worst trades for several reasons:
- Time decay: Options contracts have time decay, meaning their value decreases as expiration approaches. When the market is in a state of turmoil and uncertainty, such as a crash, the pace of time decay can accelerate, reducing the value of OTM options more quickly.
- Lack of intrinsic value: OTM options have no intrinsic value, meaning they are worthless if the underlying asset’s price does not move enough to make them ITM. During a market crash, it is unlikely that the VIX will move significantly higher, reducing the chances of OTM VIX calls increasing in value.
- Inverse relationship: The VIX and stock market often have an inverse relationship, meaning that when the stock market crashes, the VIX typically rises. However, the VIX rise may not be enough to make OTM calls valuable, and the increase in VIX may also be offset by the decrease in the value of the calls due to time decay.
In conclusion, buying OTM VIX calls during a market crash can be a risky trade as it is subject to the combined effects of time decay, lack of intrinsic value, and an inverse relationship with the stock market.
Equidistant Calls and Puts
Actually you can set up a conversation with ChatGPT:
My question: Explain OTM calls are trading equidistant OTM puts indicates more risk to the upside
ChatGPT: Buying Out of The Money (OTM) call options means the investor is betting on a price increase of the underlying asset above the strike price of the option. These options have lower cost but a higher risk of expiring worthless.
Trading equidistant OTM puts, on the other hand, means the investor is betting on a price decrease of the underlying asset. This strategy can provide limited profit and a higher risk of loss, as the price has to move significantly below the strike price for the option to have value at expiration.
Thus, buying OTM calls indicates more risk to the upside, while trading equidistant OTM puts indicates more risk to the downside.
My next question: Why OTM calls trading equidistant with OTM puts indicate more risk to the upside?
ChatGPT: OTM calls and equidistant OTM puts both have a higher likelihood of expiring worthless, as they require a larger price move in the underlying asset to generate profit.
However, when OTM calls are trading equidistant with OTM puts, it suggests a heightened expectation for price volatility in the market. In this case, the greater risk lies with the OTM call options, as they require a larger upward price movement in the underlying asset to be profitable. This increased risk to the upside is why OTM calls trading equidistant with OTM puts indicate more risk to the upside.
All of the above I did in a few minutes and all questions were immediately answered. Since I am using ChatGPT, I have not opened up Google search anymore. I asked the same questions to Google but only for a load of unsolicited ads back. I did the same on forum sites like Reddit and eventually got some valuable insights. But not as fast and comprehensive as ChatGPT.
In the next post, I will look at using ChatGPT to support real-time options trading.