Options Trading in Volatile Markets

When there is uncertainty in the markets, many trading opportunities appear, especially in the options market.

Best options strategies for volatile markets

The stock market has been extra volatile lately as war fears linger and the government is beginning to cut off the quantitative easing that stemmed from the Covid-19 pandemic.

To take advantage of these market swings, traders can use options to bet on a direction or simply just on volatility itself. While options can be a great way to bring in some profits, they are complex and should not be used by beginner traders who do not understand them completely.

When markets are volatile stock prices will be moving up and down much quicker than normal. The technical term for this is implied volatility.

Because of the larger swings, traders will be willing to pay more for option contracts since they know the market will be moving quickly and this could drive option prices even higher.

In other words, when options are more expensive, they are implying that stocks will have more volatile swings going forward.

Option selling strategies

When implied volatility in the market is high, it can be a great time to write options contracts to take advantage of their elevated prices.

When you sell or write an options contract you are betting that volatility is going to decrease. Depending on whether you sell a call or a put, you could also be betting on a direction, however, option selling strategies work great if the stock doesn’t move at all either.

The most popular ways to short volatility with options would be with a short strangle or a short straddle. A short strangle consists of selling a call with a higher strike price and selling a put with a lower strike price. If the stock only moves a little bit or not at all and implied volatility decreases, then this will make money.

A short straddle consists of selling both a call and a put option with the same strike price that is usually at the current stock price. This trade will profit if volatility drops, and the stock does not move much at all.

It is important to note that selling options is a high probability bet but the risk is much higher than the reward potential if you do not manage your risk correctly.

Option buying strategies

Even though implied volatility is higher than normal, this does not mean it cannot go higher.

While volatility will generally always contract eventually, in the short term it can continue higher just as quickly as it can come down. If you believe that implied volatility will get higher soon, this is when you can consider buying options. Buying strangles and straddles is the exact opposite of selling them, therefore you get rewarded when the stock moves a lot and volatility moves higher.

These strategies generally require much less capital and can provide unlimited reward potential in exchange for a lower probability of profiting when compared with option selling strategies.

Regardless of which route you choose to pick; it is important to note that options are best used to protect your overall investment portfolio. As opposed to just taking blind bets on direction or volatility, it is a great idea to place trades that will hedge your overall market exposure in your portfolio.

If you fear a sharp downward move and a spike in volatility in one of your holdings, then you can buy a straddle or a strangle so that way if the volatility does keep increasing your portfolio can be adequately hedged to reduce drawdowns.

Protective puts

Buying a protective put on your holdings may not be the worst idea either. A protective put is when you own 100 or more shares of a stock and then you buy a put option. A put option is like stock insurance, so if the market crashes, then you will be protected to the downside.

This protection is not free though, and you must understand that if the market does not move at all or goes up after you purchase a protective put, you will probably lose the premium you paid for the put as insurance.

Some people will employ rolling put hedging strategies, meaning you buy a put that expires for example 90 days out. You will then close this put out and buy a new 90 day put every 30 days.

As each day goes on the put option will become weaker since it is losing time value. You can minimize this loss in time value by rolling your puts, or simply closing them and reopening a new one 90 days away as we did in this example.

By doing this, your protective put will always provide the best protection and you won’t ever let them expire worthless and lose all the money you paid for them.