Volatility Trading Strategies for the Beginner Trader

Volatility trading strategies are, as the name suggests, strategies that you can use to profit from volatility trading, which is different from traditional trading.

In conventional investing, when an investor buys a stock, the direction the stock price takes is very important. If the price goes up they will make money, and if it goes down they will lose money. The reverse is true in short selling. When you sell a stock short, you make money when the price goes down and you lose money when the price goes up.

Volatility trading can be different because when you trade volatility with the right strategies, you can make money no matter which direction the underlying stock goes. This is because when you trade volatility, what matters is the Cut price movement and not in which direction the price is moving.

Volatility trading can be a great way to make money, but it also has its drawbacks. For this reason, you should definitely make sure to use smart volatility trading strategies when getting into this game. In this article, we will cover a few that beginner traders can try.

Some volatility trading strategies

1. Buy put options

The first of the volatility trading strategies we’ll look at is to buy put options. A put option is the option of to sell a share at a given price. For example, let’s say you buy a put option on Coca-Cola Consolidated Inc (Nasdaq: COK) with a strike price (a fixed price that the owner of the option can buy or sell) of $ 250. You will have the option of selling a share of Coca-Cola for $ 250. If the COK price exceeds $ 250, the put option is considered “Out of money. “Because you wouldn’t want to exercise your right to sell COK at $ 250 when you could sell it at a higher price without the put option.

Let’s say, however, that Coca-Cola drops below $ 250 – say to $ 245. Now your option is considered “in the money. “If you buy a Coca-Cola share at $ 245 and exercise your right to sell it at $ 250 with the put option, you will immediately earn $ 5. (Less the price you paid to buy the option itself – known as the bounty).

If you are bearish on a stock and think it will go down over time, you can buy – or “go long”- on a put option to take advantage of the fall in the share price. As an example, let’s say that Coca-Cola is currently selling for $ 250 and you think it will go down over the next six months. In an attempt to profit from this, you buy a put option on Coca-Cola with an exercise date in six months and with an exercise price of $ 245. Plus, you pay $ 5 to purchase the option.

In order to make money on this put option, you will need the stock price to drop by more than $ 10. This is because the put option is only in the money if the share price goes from $ 250 to $ 245. But you also need to factor in your initial $ 5 investment in the put option. Now let’s say the price of Coca-Cola drops to $ 235 on the date of the strike. You will do the following: $ 245 {the strike price} – $ 235 {price of the underlying asset} – $ 5 {your initial investment} = $ 5.

Now that may not seem like much. But consider this: your initial investment was only $ 5 initially. To calculate the total return on your investment, you divide your return by your initial investment – $ 5 / $ 5 = 100%. A quick return to three digits! This is what makes it a powerful volatility trading strategy.

2. Sale of call options

The second of the volatility trading strategies that we will look at is writing or “writing” call options. A Call option is an option for to buy a share at a given price. When you buy a call option, you are doing it because you are bullish on the underlying security. For example, let’s say that Coca-Cola is currently trading at $ 250 and you think the price will appreciate by more than $ 10 in the next few months. You can buy a call option with an exercise price of $ 255 for an initial investment of $ 5.

If the stock increased to $ 265 on the exercise date, you could exercise your call option. This gives you the right to buy the stock at $ 255. Then you immediately sell the stock for $ 265 on the open market. This gives you a spread of $ 10. When you subtract your initial investment from $ 5, you end up with a profit of $ 5 on the trade.

Now, we have already discussed that one bearish volatility trading strategy that you could use is to buy put options. But another one that you can use is to sell call options. While buying a call option is a bullish strategy – you would expect the price of the underlying stock to rise – selling a call option is a bearish strategy.

When you sell a call option, you keep the premium you earn. For example, if you sell a call option on Coca-Cola with a strike price of $ 260 for $ 5, you keep the initial premium of $ 5 that you earned from the trade. Now, if the price of Coca-Cola declines as expected, the call option will remain out of the money. And then it will not be exercised. In this case, you keep your entire premium as a return on the trade-in.

However, if Coca-Cola goes to $ 262, the call option will be exercised. As the seller of the call option, you are now obligated to sell Coca-Cola shares to the option holder for $ 260. This means that if you were to buy the stock in the open market for $ 262 and then sell it to the option holder for $ 260, you would lose $ 2 on the stock market. That $ 2 would then be deducted from the bonus you earned to calculate your total return, so $ 5 – $ 2 = $ 3. On the plus side, you still made some money.

3. Legs and chokes

Straddles and strangles are volatility trading strategies that use more than one option position. For example, in a straddle you trade two options with the same strike price and the same date – one is a call and the other is a put.

Here is how the short stride works. In a straddle, you sell a call option and a put option with the same strike price and the same date. When you sell these options, you receive both bonuses.

When using a straddle approach, you would expect price volatility to be low. If this turns out to be correct, you will be able to keep most or all of the bonuses you have earned.

A short choke Is similar. However, there is one essential difference. In a short choke, the call and put strike prices are different. Usually the buy price is higher than the sell price. Both are out of the money. And both options are roughly the same distance from the current price of the underlying stock.

So if the stock is trading at $ 10, you can sell the call at $ 12 and the put at $ 8. While this strategy usually earns you a lower premium than straddle, it also lowers some of your risk.

Final thoughts on volatility trading strategies

Volatility trading can definitely earn you a lot of income. At the same time, it can be risky. By sticking to volatility trading strategies that you fully understand, you will be able to better manage your risks and make money in the market.

If you want to learn more about volatility and options trading, I strongly suggest you sign up for the wonderful and free Trade of the day e-letter in the subscription box.

Hope you now have a better understanding of some beginner volatility trading strategies. And be sure to watch the next article in this series on the question: how to trade volatility?

Read more: Volatility Trading Strategies for the Beginner Trader

About Brian M. Reiser

Brian M. Reiser holds a Bachelor of Science in Management with a concentration in Finance from the School of Management at Binghamton University.

He also holds a BA in Philosophy from Columbia University and an MA in Philosophy from the University of South Florida.

His primary interests at Investment U include personal finance, debt, tech stocks and more.

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