How Implied Volatility Shifts Put Option Profitability Across Strikes

Summary

The document asks how to choose a put strike that would maximize gains during a large market decline. It describes a historical SPY example and a backtest in which percentage gains varied substantially by strike, with the observed peak occurring at an out-of-the-money strike. The question is what shapes that payoff pattern and whether the best strike can be selected in advance from an assumed market drop.

The answer emphasizes that a price-drop assumption alone is insufficient: an implied volatility assumption is also needed to estimate option values. If implied volatility rises, vega can contribute more to profit than delta, shifting the most profitable strike toward lower, still out-of-the-money strikes. This is an illustrative explanation, not a general strike-selection rule. Results depend on the volatility path, option pricing inputs, and the specific dates and contracts; the document offers no tested forecasting procedure.

Key ideas

• A projected underlying price decline alone does not determine which put strike will produce the largest percentage return.
• The implied volatility assumption affects projected option values and profitability across strikes.
• When implied volatility rises substantially, vega can outweigh delta as a source of option profit.
• An out-of-the-money put may outperform a put that becomes in the money under a particular scenario.

Tags

# Most profitable PUT strike price in these times of high volatility?


# Most profitable PUT strike price in these times of high volatility?












At close 3/13/20 SPY was at 270.2, by close 3/16 it dropped to 239.41 ~ 8.8% drop... I'm looking at how to capitalize on these big swings with options.

I'm backtesting option strategies and plotted the gains for various PUTS by strike from 3/13 close to 3/16 close. I see the 'peak' gain of 600% is at a strike price of 185 so over 30% lower than ATM on 3/13.

Question is how could I figure out ahead of time what the optimal strike price to buy a PUT at is that maximizes my gain if there is a ~8-10% drop? What drives the shape of the curve below?

Curve of PUT price on 3/16 / PUT price on 3/11 by strike...

## Answer by Lliane (score 3, accepted)

https://quant.stackexchange.com/a/53285

You need an implied volatility assumption in addition to the price drop assumption to compute that.

With a higher implied volatility increase the "profitability peak" you have will gravitate towards lower strikes. Vega is a more important pnl factor in that situation than pure delta, it's not surprising that an option which is still OOM would be more profitable than an option that became ITM.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.