DJT volatility is soaring! How to short it?

As the U.S. election day approaches, investors across the stock, forex, bond, commodities, and crypto markets are undoubtedly refocusing on a range of "Trump trades."

The stock of Truth Social’s parent company, Trump Media & Technology Group, surged as much as 17% on Tuesday morning before briefly turning negative. Due to volatility, trading was temporarily halted, and upon resuming, the stock began to recover. For months, traders have been betting that a Trump victory could boost Truth Social's value, though it remains challenging to justify its current valuation even if Trump returns to the White House.

Trump Media & Technology Group is heavily loss-making with minimal revenue, and its primary product—Truth Social, a conservative social network—is still relatively small. However, Trump Media has become a multibillion-dollar “meme stock,” a popular way for traders to bet on election outcomes, which has simultaneously boosted the net worth of its largest shareholder.

Venture capitalist Gene Munster recently commented in an interview that a Trump defeat could slash Trump Media’s valuation to just $1 billion, with some estimating an even lower figure. “I wouldn’t touch DJT stock because I think the downside risk is too high and the upside is uncertain,” he remarked.

Amid such market conditions, Trump Group’s volatility has surged! In options strategy, one approach well-suited to this environment is short volatility strategies.

What is Volatility?

Volatility is a term describing how quickly the price of a stock, future, or index changes. In options, the volatility of the underlying asset and option prices are positively correlated. This means that the greater the asset's volatility, the higher the option price, and vice versa. The more an underlying asset fluctuates, the greater the likelihood that a buyer's expectations will be realized, which increases the cost. For the seller, higher asset volatility means higher risk, which leads to a higher option premium.

There are three types of volatility associated with options: Historical Volatility (HV), Forecast Volatility, and Implied Volatility (IV).

• Historical Volatility (HV) reflects the actual past volatility of the underlying asset, calculated by analyzing price changes over a previous period.

• Forecast Volatility is inferred based on historical volatility and is used to theoretically price options.

• Implied Volatility (IV) is the market’s present estimate of future volatility, derived from the option’s current price.

However, theory and reality may differ, as the actual volatility of the underlying asset may deviate from the market’s prior estimate. This forms the basis for trading options implied volatility.

Put differently, when implied volatility falls, option sellers are generally pleased, while option buyers incur losses. The goal of volatility traders is to identify situations where implied volatility may be mispriced to establish a profitable position.

How to Short Volatility?

In options trading, shorting volatility primarily involves selling options to earn time value, as option time value shrinks when volatility decreases. Here are some common strategies for shorting volatility:

1. Selling Straddles or Strangles

   1. Straddle: Selling both a call and a put with the same strike price, usually used when the underlying price is expected to be stable or have minimal movement.

   2. Strangle: Selling call and put options with different strike prices, suitable when low volatility is expected, but the direction is uncertain.

   3. Caution: Both strategies are naked short positions, carrying high risk, as volatility spikes or drastic price movements can lead to significant losses.

2. Iron Condor

   1. Selling call and put options on either side of the underlying price, while buying further out-of-the-money options as protection.

   2. Suitable for scenarios with expected low volatility or limited price change, though it can incur losses in highly volatile markets.

3. Iron Butterfly

   1. Similar to the Iron Condor but involves selling a straddle at the center strike price and buying options further out for protection.

   2. This strategy also profits from low volatility but offers a smaller reward-to-risk ratio compared to naked straddles.

4. Calendar Spread

   1. Selling near-term options and buying longer-term options at the same strike price to short volatility.

   2. If volatility falls, the near-term options decay faster, allowing for potential profits.

5. Selling Single-Leg Calls or Puts

   1. Selling calls or puts when the underlying asset is expected to show little to no movement, allowing the seller to earn option time decay.

   2. This approach carries high risk, typically best suited for confident market predictions.

6. Ratio Spread

   1. Selling multiple contracts of one option type while buying fewer contracts of the same type, often used when expecting a decline in volatility.

   2. This strategy increases income from sold options when volatility drops but also raises risk.

Each of these strategies has pros and cons and is generally suited to environments with clear expectations of volatility changes. In general, short volatility strategies require careful risk management, as volatility increases or unexpected market swings can lead to substantial losses.