Want a killer combination for eye-popping returns when selling premium? It’s very simple and easy to remember. I used it yesterday during a mentorship session to show a 60% return on a high probability short strangle trade. Some of you probably already know the combo. It’s not really a secret, unless you haven’t heard of it before. Now that I think of it, everything you don’t know is a secret.

Let’s reveal it.

Cheap Stock + High Implied Volatility = Option Sellers’ Dream

Like any well constructed argument, we need some case studies to prove our point, a supporting cast for our star actor.

YETI

Suppose you’re shopping for the purest of pure cash flow trades – the short strangle. The reason for its purity is simple. It’s delta neutral and doesn’t involve as many legs as a Condor. My suggested process for finding candidates involves three steps:

Step #1: Sort your watchlist by price.

Step #2: Focus on the stocks with a higher Implied Volatility Rank (IVR)

Step #3: Ignore stocks that have earnings in the next month.

For step #1, I usually use $20 as my lower bound. It’s challenging to find enough premium to justify the commission on stocks sub-$20.

For step #2, I have to use implied volatility and not implied volatility rank if it’s a newer company that hasn’t been around for one year.

At $25.31 and an implied volatility of 64%, YETI was one of the first good-lookers on my list. Here’s the chart:

To build the short strangle, we could sell the July $30 call and $22.50 put. The call delta is 22, and the put delta is 25. We could have sold even lower deltas, but I liked the premium available in the closer to the money strikes.

The total credit received was $1.45, which is a lot! That’s the max reward that will be captured if YETI sits between $30 and $22.50 at expiration. The reason the credit was so high is because of the high implied volatility reading. Remember, it was 64%. To put that in context, the S&P 500 has an implied volatility of 15%.

The initial margin requirement or cost is $226.50. It’s low because of Yeti’s cheap price tag. Using both metrics, we can calculate the potential return on investment (ROI):

ROI: $145/$226.5 = 64%

Tasty! The one caveat is the margin requirement will increase if the stock rises or falls too far, so the actual capital committed to the trade could rise and thus lower the potential return on investment. But, whatever, it’s still fantastic.

Obviously we don’t have to do a short strangle. We could sell puts if bullish or calls if bearish. The takeaway is that YETI provides an attractive backdrop for selling options because of its low price tag and high implied volatility. Remember that when seeking other candidates.

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