Utiliser la volatilté

Three (3) Options Trading Strategies to Fight Volatility

One rule of thumb regarding the VIX is that it measures the expectation priced into options for the potential movement of the SPX over the next 12 months (based on 1 month of option pricing).  So a VIX of 36 means that SPX option traders/market makers are pricing that the SPX could move up OR down 36% over the next 12 months quite a high volatility level on both a historical and a real basis, in my view.

Remember that for every option purchase there is a corresponding option sale so with implied volatilities high (which, combined with time value, comprise the premium in option prices), let's take a look at the basics of some option trading strategies that incorporate option selling.  This way you can have a portion of your portfolio that receives time decay and can benefit from volatility going down.

Here are a few strategies that will allow you to sell implied volatility/option premium, as well as buying it:

1.  Selling Covered Calls/Covered Puts
The simplest of these 3 strategies, this is basically selling an out-of-the-money (OTM) Call against a long stock position you may own.  This can be done at the time of the stock purchase (Buy/Write), or against an existing stock position (to protect gains and/or lower cost basis).

On the flip side, against a short stock position, you can sell an out-of-the-money "Covered Put".  In both of these situations, you end up collecting a "credit" for selling an option, putting yourself "short" time premium and implied volatility.  The tradeoff for receiving a credit and lowering your cost basis is that you will limit your potential upside gain to the strike you sold.  You will receive the benefit of time premium decay ("Theta") and also potentially gain if the implied volatility on the option you sold comes down.

2.  Credit Spreads
Without going into too much depth, a Credit Spread (also known as a "Vertical Bull or Bear Spread"), involves selling an option and buying another option of the same stock in the same expiration month, but of a different strike.

Normally on a credit spread we would be selling an at-the-money (ATM) or OTM strike and buying a further out strike.  So, for example, a Bearish December Credit Spread on XYZ stock (with XYZ shares at 52) might be to sell the December 55 Call while simultaneously buying the December 60 Call.

3.  Horizontal Calendar Spreads
The most advanced of the strategies I'm discussing today is Calendar Spreads.  This involves trading an option in the Front or Second month for example, and hedging with an option of the same stock, same strike, but in a further out Expiration month.  The further out option can be as far out as LEAPs out a year or two ahead.

A Calendar Spread can in effect be a "Vega" trade, but it can also be done as a "Theta" collection trade.  The far out options are basically all Vega, so if you are banking on implied volatilities coming down, you would be looking at Buying the Front or Second month option and Selling the Further out option, such as a LEAP.

Another simpler version of a Calendar Spread would be to flip this around by selling a Front Month as it approaches Expiration and buying a Second Month, in order to collect the rapid time decay of the final two weeks heading into Expiration.

These kinds of strategies are fairly complex and should be evaluated in an Options Position Analytic software of some sort (most option brokers offer these in their trading platforms nowadays) – in addition you will want to track how the further out implied volatilities move in relation to the front months, as they will not move at the same rate.

If you are interested in trading these kinds of advanced options strategies and more, you will generally need a Margin Account with your Brokerage House, as well as the proper Options Trading Approval to trade a variety of option strategies.  Contact your Broker for more info.

And as I mentioned, I am just touching on the basics of these multi-leg advanced trading strategies.  There are many other strategies where you can benefit from moves in implied volatility and receive time decay, such as Diagonal Spreads, Ratio Spreads, Butterflies, Iron Condors, etc. 

Most often utilized strategies utilized are Debit Spreads (good with ETF's) and Diagonal Spreads.  Research "white papers" available at no cost on these two specific strategies.