Volatility options strategies
After receiving numerous emails from people regarding this topic, I wanted to take an in depth look at option volatility. This discussion will give you a detailed understanding of how you can use volatility in your trading. Option volatility is a key concept for option traders and even if you are a beginner, you should try to have at least a basic understanding. Strategies other words, an options Vega is a measure of the impact of changes in the underlying volatility on the option price. All else being equal no movement in share price, interest rates and no passage of timeoption prices will increase if there is an increase in volatility and decrease if there is a decrease in volatility. Therefore, it stands to reason that buyers of options those that are long either calls or putswill benefit from increased volatility and sellers will benefit from decreased volatility. The same can be said for spreads, debit spreads trades where you pay to place the trade will benefit from increased volatility while credit spreads you receive money after placing the trade will benefit from decreased volatility. Here is a theoretical example to demonstrate the idea. Consider a 6-month call option with a strike price of This shows you that, the higher the volatility volatility, the higher the option price. Below you can see three screen shots reflecting a simple at-the-money long call with 3 different levels of volatility. The first picture shows the call as it is now, with no change in volatility. You can see that the current breakeven options 67 days to expiry is You can see that the current breakeven with 67 days to expiry is now One of the main reasons for needing to understand option volatility, is that it will allow you to evaluate whether options are cheap or expensive by comparing Implied Volatility IV to Historical Volatility HV. Below is an example of the historical volatility and implied volatility for AAPL. This data you can get for free very easily from www. This shows you that traders were expecting big moves in AAPL going into August You can also see that the current levels of IV, are much closer to the 52 week high than the 52 week low. This indicates that this was volatility a good time to look at strategies that benefit from a fall in IV. Here we are looking at this same information shown graphically. You can see there was a huge spike in mid-October Drops like this cause investors to become fearful and this heightened level of fear is a great chance for options traders to pick up extra premium via net selling strategies such as credit spreads. Or, if you were a holder of AAPL stock, you could use the volatility spike as a good time to sell some covered calls and pick up more income than you usually would for this strategy. Every option strategy has an associated Greek value known as Vega, or position Vega. Therefore, as implied volatility levels change, there will be an impact on the strategy performance. We know Historical Volatility is calculated by measuring the stocks past price movements. It is a known figure as it is based on past data. I want go into the details of how to calculate HV, as it is very easy to do in excel. The data is readily available for you in any strategies, so you generally will not need to volatility it yourself. The main point you need to know here is that, in general stocks that have had large price swings in the past will have high levels of Historical Volatility. As options traders, we are more interested in how volatile a stock is likely to be during the duration of our trade. Historical Volatility will give some guide to how volatile a stock is, but that is no way to predict future volatility. The best we can do is estimate it and this is where Implied Vol comes in. It is a key input in options pricing models. This could include and earnings announcement or the release of drug trial results for a pharmaceutical company. The current state of the general market is also incorporated in Implied Vol. If markets are calm, volatility estimates are low, but during times of market stress volatility estimates will be raised. One very simple way to keep an eye on the general market levels of volatility is to monitor options VIX Index. The way I like to take advantage by trading implied volatility is through Iron Condors. With strategies trade you are selling an OTM Call and strategies OTM Put and buying a Call further out on the upside and buying a put further out on the downside. Sell 10 Nov SPY Puts 1. We would also profit from this trade if all else being equalimplied volatility options. The first picture is the payoff diagram for the trade mentioned above straight after it was placed. Notice how we are short Vega of This means, the strategies position will benefit from a fall in Implied Vol. This is a fairly extreme example I know, but it demonstrates the point. It is sometimes also referred as the Fear Index as it is a proxy for the level of fear in the market. When the VIX is high, there is a lot of fear in the market, when the VIX is low, it can indicate that market participants are complacent. As option traders, we can monitor the VIX and use it to help us in our trading decisions. Watch the video below to find out more. There are a number of other strategies you can when trading implied volatility, but Iron condors are by far my favorite strategy to take advantage of high levels of implied vol. The following table shows some of the major options strategies and their Vega exposure. I hope you found this information useful. Let me know in the comments below what you favorite strategy is for trading implied volatility. With volatility looking like it may be spiking back up again, now is a great time to review this article. Thanks for the explaination, really clear and concise. This has helped me greatly with the iron condor strategy. Typically I stay away from the weeklies to be honest, unless I am using them for a short-term hedge. Clear n great illustration: Need ur help on clarification. A long butterfly is a debit spread, why would it be suitable volatility decreased implied volatility compared to other debit spread? Is options due to the volatility Vega on both the 2 ATM Call compared to both vegas of 1 ITM n 1 OTM? This article was so good!!! It answered lot of questions that I had. Very clear and explained in simple English. Thanks for your help. I was looking to understand the effects of Vol and how to use it to my advantage. This really helped me. I do still would like to clarify one question. I was thinking of doing a OTM Reverse Calendar spread I had read about it However, my fear is that the Jan Option would expire on the 18th and the vol for Feb would still be the same or more. I can only trade spreads in my account IRA. I can not leave that naked option till the vol drops after the earnings on 25th Jan. May be I will have to roll my long to March—but when the vol drops—-???? I will lose on my strategies from a crash in volatility? Hi Tonio, there are lots of variable at play, it depends on how far the stock moves and how far IV drops. As a general rule though, for an ATM long call, the rise in the underlying would have the biggest impact. IV is the price of an option. You want to Buy puts and calls when IV is below normal, and Sell when IV goes up. On the other hand, option pricing models are rules of thumb: If you own a options — say AAPL C — and even though the stock price of is unchanged the market price for the option just went up from 20 bucks to 30 bucks, you just won on a pure IV play. You will never, ever, EVER have a profit higher than the you opened with or a loss worse than thewhich is as bad as it can possibly get. However, the actual stock movement is completely non-correlated with IV, which is merely the price traders are paying at that moment in time. It just means that traders are currently paying 5 million times as much for the same Condor. Your options remember are contracts to buy and sell stock at certain prices, and this protects you on a condor or other credit spread trade. It helps to understand that Implied Volatility is not a number that Wall Streeters come up with on a conference call or a white board. Historic volatility is strategies, but these people are paying as if it was 30! My understanding is that if volatility decreases, then the value of the Iron Condor drops more quickly than it would otherwise, allowing you to buy it back and lock in your profit. Apologies Jim Caron, I must have missed replying to your initial comment. In order to replicate a long position in a stock using options, you would sell and ATM put and buy and ATM call. Just found your site on facebook. Fantastic site, I love how you break down some difficult topic and communicate them in a very easy to understand fashion. Keep up the good work. Of course we know you put in a deliberate mistake too see if we are paying attention. There is no greek symbol called Vega. If we were using a Greek symbol it would be Kappa. There are some expert taught traders to ignore the greek of option such as IV and HV. Only one reason for this, all the pricing of option is purely based on the stock price movement or underlying security. If the option price is lousy or bad, we always can exercise our stock option and convert to stocks that we can owned or perhaps sell them off on the same day. Only with exception for illiquid stock where traders may hard to find buyers to sell their stocks or options. I also noted and observed that we are not necessary to check the VIX to trade option and furthermore some stocks have their own unique characters and each stock option having different option chain with different IV. As you know options trading have 7 or 8 exchanges in the US and they are different from the stock exchanges. They are many different market participants in the option and stock markets with different objectives and their strategies. I also observed that a lot of blue chip, small cap, mid-cap stocks owned by big institutions can rotate their percentage holding and controlling the stock price movement. However, HFT activity also may cause the drastic price movement up or down if the HFT found out that the institutions quietly by or sell off their stocks especially the first hour of the trading. If we long option, we want low IV in hope of sell the option with options IV later on especially prior to earning announcement. Or perhaps we use debit spread if we are long or short an option spread instead of directional trade in a volatile environment. Therefore, it is very difficult to generalise things such as stock or option trading when come to trading option strategy or just trading stocks because some stocks have different beta values in their own reactions to the broader market indexes and responses to the news or any surprise events. I thought that, generally, one wants a higher IV environment when deploying credit spread trades…and the converse for debit spreads…. Yes, you vol to be low when buying spreads, no matter if your trading a stock or an ETF. Remember volatility is only one piece of the puzzle. Yes if price drops, vol will rise, but you may be losing money on options spread as the price movement will likely outweigh the rise in vol. If price stays the same and vol rises, you make money. Blog My Story Work With Me Contact. Read This Free Report Volatility Trading Made Easy - Effective Strategies For Surviving Severe Market Swings. May 6, at July 24, at 9: Options Trading IQ says: July 25, at August 13, at 3: Volatility 1, at September 3, at 9: October 20, at 4: October 22, at 3: December 1, at December 29, at 8: March 29, at March 30, at 2: August 30, at 5: April 26, at 9: May 22, at 6: May 27, at 5: September 1, at 1: September 2, at 8: December 29, at 6: March 1, at 2: March 22, at March 23, at Volatility strange death of Volatility Stasha Macro World. November 5, at January 19, at 4: Vix Options And Futures How To Trade Volatility For Profit Fx Robot Binary Options. Iq Options Contract The Official Forex Trading Site. 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