With everything that is currently happening in the markets and in the world – it seems as though this could be a good time to take a look at different ways to trade volatility – not only as a way to hedge trading positions that we might already have on – but also as a way to take advantage of potential rises and declines in volatility levels through the use of various option trading strategies – like iron condor trades, calendar spreads, credit spread plays and numerous weekly options trading strategies.
The traditional way to use options in regards – or in response – to volatility is to use them as protection for our investment portfolios.
The most basic example of this is a retail trader who might own some shares of stock and who might be afraid of a market decline which we know and have seen can happen so suddenly and to such a great degree in this more volatile market environment.
In a scenario where a retail trader might be looking for some sort of insurance against a decline – they can simply buy a put option. Buying a put option will allow the trader to ‘sell’ their stock at a certain level – which is whatever level they purchased the put option at – regardless of what happens.
For example – let’s say that Grampa Joe owns 100 shares of XYZ stock at 80 dollars – and due to numerous factors both in the news and the market – Grampa Joe wants to protect his 100 shares from a potential crash or big sized decline.
What he can do is simply purchase the 75 Put option – either a short dated option or a longer dated option (for example a LEAP option). What this will do is allow him to sell his 100 shares at 75 either before or at the expiration date of that option.
So, if there were a sudden crash and the price of XYZ stock fell to 40 dollars per share – rather than realizing a 50 percent loss in his stock position – Grampa Joe can take advantage of the put option that he bought at 75 – which is like his ‘insurance policy – and he can sell out his stock for 75 dollar instead.
The other thing to consider now that the weeklys are available – is that weekly options can also be used as shorter term insurance vehicles.
This is just one of the many option trading tools that can be used having to do with volatility – and perhaps the most basic.
In an upcoming post we will get into more complex and what I consider much ‘cooler’ option trading tricks and tools for trading volatility. Stay tuned…