Option & Volatility Trading Strategies
Investors can select from several trading strategies to take advantage of high volatility options. These strategies can be used with all types of options, and they can be used weekly, monthly or on longer time frames. You can use a free online stock scanner to select a high volatility security that has options. After analyzing the security to be sure it’s a suitable trading candidate, you can select which option strategy is best suited for the trade.
Straddle Option Nondirectional Strategy
The straddle option strategy is used when you believe the security will make a sharp move up or down but are not sure in which direction. You open the trade by buying an equal number of at-the-money calls and puts at the same time with the same expiration. For example, if the stock is trading at $50, you could buy three call options and three put options at the $50 strike price. As long as the stock price is above the call option strike or below the put option strike before expiration, you have a profit. The amount you make on the winning side of the trade will offset the amount you paid for the losing side.
Strangle Option Nondirectional Strategy
The strangle option strategy is another nondirectional strategy that uses less expensive out-of-the-money options. It is a cheaper strategy than the straddle strategy but can be just as effective. This trade consists of buying an equal number of out-of-the-money calls and puts with the same expiration. For example, a stock is trading at $40 and you believe the price will go up $5 to $45. You go out $5 from the $40 strike price and buy one call option at the $45 out-of-the-money strike and buy one put option at the $35 out-of-the-money strike. You make your profit when the stock price is either above the call option strike or below the put option strike.
Bull Call Directional Spread
As the name implies, you use a bull call spread when you believe a volatile stock will make a modest move up. The spread consists of buying an in-the-money call and selling an out-of-the-money call with the same expiration. For example, if the stock is selling at $50 a share, you could buy a call option with a $45 strike and sell the call with a $55 strike. The spread profits when the stock price moves higher than the call strike purchase price.
Bear Put Directional Spread
The bear put spread is used when you believe the underlying security will decline in price. You open the spread by buying an in-the-money put and selling an out-of-the-money put. For example, if the stock is selling at $40, you could buy an in-the-money put option with a strike price of $45 and sell the out-of-the-money put at $35. You make a profit when the stock drops below the put strike purchase price.
Based in St. Petersburg, Fla., Karen Rogers covers the financial markets for several online publications. She received a bachelor's degree in business administration from the University of South Florida.