While that might be the title of a song made popular by Nat King Cole, it's also a fairly accurate description of market behavior during the summer months. Low volume can lead to chop in tight price ranges. That chop renders the next direction hazy. Because of the low volume, however, breakouts can get out of hand quickly, with price movements earning the label "crazy."
Low volume and tight ranges can lead to falling implied volatilities.
Option Volume by Month, 2012, Supplied by OIC:
On June 1, 2012, composite IV's for the SPX JUL cycle, 46 days to expiration, were at 24.14 percent. The following iron condor, at 10:55 in the morning, would have brought in a theoretical $1.62 credit per contract according to OptionNet Explorer. With two-way commissions subtracted, the margin would have been $837.50.
Theoretical One-Contract Iron Condor, ONE Chart:
On August 6 of that year, with the composite IV's for the SEP options at a much lower 14.65 percent, an iron condor established using the same guidelines would have theoretically brought in only $1.05 per contract at 10:55 am and would have resulted in a margin, after two-way commissions, of $895.00.
Theoretical Iron Condor Established August 6, 2012 at 10:55 AM, ONE Chart:
Each of these iron condors was established using the following guidelines: sell the first call with a delta less than 10.00 and buy a call 10 points higher, and sell the first put with a delta higher than -10.00 and buy a put 10 points lower, excluding the "5 point" strikes. In other words, sell the 1270 put instead of the 1275, although the 1275 is the first put with a delta higher than -10.00.
Why is the credit received so much lower than the $1.62 per contract in the first case? The delta on the sold call does turn out to be lower, and that impacts the credit received. However, most of the impact can be pegged on the lower IV's. That's an effect seen in some summers when volatilities sink while prices churn in a tight range.
If you're willing to risk $837.50 in margin for 46 days in the first trade, does that necessarily mean that you're willing to risk $895.00 for 46 days in the second trade? Not necessarily.
What is an option seller--those who trade credit spreads, iron condors and butterflies, among other such trades--to do, then, during the summer when prices are lazy, volume is low, and implied volatilities dip? What if a trade is entered under these conditions, and implied volatilities suddenly expand as prices drop? Should option sellers change their strategies during the summertime?
Here are the choices options sellers face:
Accept less credit: This may make sense if the option trader studies charts and feels that price movements will likely remain subdued and implied volatilities may remain low for the duration of that trade. In such a case, a volatility hedge such as an out-of-the-money put may make sense. Such puts would be cheap to buy when implied volatilities are low. If you back-tested your trade through all kinds of market conditions, you'll know how it performs during lazy, hazy, crazy summers.
Enter the trade earlier, more days before expiration, to collect more credit. Recognize that you're trading less margin risk for more time risk in that case. There's no free lunch. This may make some sense for iron condor sellers because of the way far out-of-the-money options expire, but it may make less sense for the at-the-money butterfly trader.
Sell the call and put closer to the money than you typically do to bring in more credit and thus have less margin at risk. In other words, you might sell the first call with a delta under 15 and the first put with a delta above -15. Recognize that your trade will get into trouble faster with a volatile or relentless price movement in one direction if this is your choice.
Change strategies if it's your opinion that implied volatilities could soon expand rapidly. Calendars, debit spreads, long calls and puts are option trades that can benefit from a rise in implied volatilities. Familiarize yourself with such new strategies before engaging in them, however. Calendars can benefit from a rise in implied volatilities if the IV's rise in the back-month option, too, and if the price movement is not too big. However, if traders deem a movement short-lived, IVs may be driven up in the near-term sold option but remain steady in the back-month long option, and that's not helping a calendar trade. Also, just as is true with a butterfly or iron condor, those calendars have expiration breakevens, and the trade must be managed in the case of a move toward or through those expiration breakevens. Long calls or puts can benefit from a rise in implied volatility if the price movement is in the right direction and happens in the right time frame. The trade won't benefit if the underlying's price zooms past your expiration breakeven the day after expiration!
Summertime price action can be lazy, hazy or crazy. If you're an experienced trader, you know what to expect. If you're relatively new to trading options, realize the trading conditions can change, depending on the season. Spend some time thinking about your options. Literally.