We cannot talk about options trading strategies without mentioning market volatility. This is because they are closely connected as the investor’s sentiments regarding the options change best on the market's volatility.
By having extensive knowledge about options as well as understanding the volatility of the market and how it affects the options, you can make a profit irrespective of the market conditions.
That said, whether you are a beginner or an experienced trader, you are probably looking for the ideal strategy to implement and get earnings. Let’s get into the details and discuss the best options strategies for high volatility.
Options Strategies for High Volatility
Due to the fact that the stock’s price rapidly fluctuates when there is high volatility, you need to understand how to time options strategies to be a successful trader.
The volatility tells you how the investors believe the stocks will move.
When the implied volatility is high, the best option is to go for strategies such as the straddle, the strangle, credit spread, and the iron condor strategy.
Options and Market Volatility in Brief
Before we get into the strategies, let’s briefly talk about implied volatility (IV) and how it affects options. The IV plays a huge role in the future value of an option. In other words, it predicts the price changes of an underlying asset which will then affect the options price.
The volatility is impacted by the demand for the options and the market’s expectations about the stock prices. Hence, when the demand for an option rises, the volatility will also rise and vice versa. Whether the IV rises or falls is very important as it influences the success of the trade.
Besides implied volatility, there is also historic volatility based on the previous data on the market, even though its impact is less significant than the IV. Therefore, you need options strategies for high volatility to perform a trade and earn profit.
The Best Options Strategies for High Volatility
Among the best options strategies for high volatility are the straddle, the strange, iron condor, naked puts and calls, and the credit spread strategy. Let’s get into more detail about each one and why it is a good option for high-volatility trading.
The straddle
This two-legged options strategy is created to capitalize on high market volatility. To trade straddle, you buy to open a call and put on the same stock at the same strike price and expiration date.
This way, you ensure to earn a profit regardless of how the price of the underlying stock moves. When it comes to a short straddle trade, the trader sells both call and put options at the same price strike in order to get premiums for both.
The straddle can be a very profitable strategy when there is a high expectation that the underlying stock will significantly rise in volatility within the set time.
The strangle
The strangle method is similar to the straddle one, given that both contain bullish and bearish trades on the same underlying stock. In the same way as the previous method, to trade strangle, you need to buy to open a call and put on the same stock with the same expiration date.
In comparison, the strangle includes a call and a put at two different strike prices. Both strikes are OTM, and they surround the stock price. This method gives a wide range of safety for the trader.
It is designed to take advantage of the market’s high volatility. The strangle strategy is intended for scenarios when the underlying stock has a high chance of making a major directional move on the market.
Iron condor
If the short strangle strategy aligns with your trading expectations, but you don’t like that it comes with unlimited risk, then the iron condor may be the right strategy for you. The setup for the iron condor consists of two OTM short vertical spreads, of which one is on the call side and the other one on the put side.
If the underlying stock remains within the strikes, the iron condor gives you a wide range to profit. The iron condor can give you a profit in a short period of time, which is why many traders opt for it when in need of options strategies for high volatility. This method also caps your losses in case you make a wrong prediction.
Naked calls and puts
While naked calls and puts is the simplest strategy you can use, it comes with a high risk if you don’t make the right prediction. For this reason, this method is intended for advanced and experienced traders.
This is the type of strategy which requires the investor to sell a call option without the security of owning the underlying stock. Whether you are bullish or you are bearish on the underlying asset while the volatility is high, you are required to sell an OTM option.
Credit spread strategy
The credit spread options strategy is a trade in which, as a trader, you purchase or sell options contracts that are of the same class, have the same expiration date but different price strike levels.
In terms of trading credit spread, the traders get paid a net credit, and they want to see the prices go lower or expire to keep the profit in the premium. The credit spread enables you to limit the risk, enabling you to calculate the amount of money you will risk once you enter an options' strategy position.
The credit spread is profitable for the trader when the premium value of the option declines and is in the trader’s favor. If the options expire OTM, the difference in the strike prices minus the net credit is the maximum loss regarding this strategy. This method is less risky than the naked calls and puts when the market is volatile as it limits the losses.
Additional Options Trading Strategies for Long and Short Volatility
Depending on whether you expect the volatility to continue going higher, you can also implement long volatility strategies such as bull call spread or bear put spread.
Bull Call Spread
The bull call spread involves buying a long call with a lower price strike and a short call with a higher strike price having the same expiration date. The trade increases in value as the price of the underlying stock rises.
Bear Put Spread
The bear put spread is the opposite and consists of one long put at a higher strike as well as one short put at a lower strike, both with the same expiration date. Such a trade increases in value as the price of the underlying stock decreases. That said, the price of the bear put spread changes only a little when the volatility changes.
When it comes to short volatility strategies, you can consider selling covered calls or a butterfly spread which results in a net debit and works best when the stock price moves sideways at your ATM strikes.
Implement the Right Strategy to Earn Profit
As mentioned, it is possible to earn a profit even during high volatility. However, to make money, you need to be familiar with the strategies and perform trades at the right time.
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More About Volatility Trading
During a trading process for options strategies, advanced traders look at the implemented volatility as the most important factor for pricing. When the IV is high, they use strategies to help them benefit from the volatility.
The strategies mentioned above take advantage of the high volatility of the market and limit the risk of a loss. Such trading strategies forecast how much the price of the stock will move despite the current market trends.
When selecting the right strategy to implement, as an investor, you should purchase undervalued options and sell overvalued options. Once you know how to forecast the IV properly, the process of buying and selling options will be much easier for you.
Final Thoughts
The market's high volatility can work well for you as a trader, as it keeps the prices of the options high, allowing you to leverage profit. However, before you make an investment, it is crucial to optimize the right trading strategy and weigh the risks. By understanding the power of the options strategies, you can effectively trade volatility and stay on the right side of the market.