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ART SANDBOX // Options Risk Graphs // DO NOT PUBLISH

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Trading options is more than just being bullish or bearish or market neutral. There’s volatility. Limitations on capital. Stronger or weaker directional biases. Whatever the scenario, you always have the choice of a logical option strategy that can be risk-defined, capital-effective, and/or have a higher probability of profit than simply buying or shorting stock.

If you’re an experienced options trader, you should be able to look at choosing a strategy as a series of binary decisions based on three primary variables:

  1. Volatility: high or low
  2. Trend: bull, bear, or neutral
  3. Time: shorter or longer term

Over the course of two articles, we’ll offer up a grid of strategies, each designed to take advantage of a combination of these three variables. Used as a reference, this might help you run through the process of making speedy trading decisions should you need or want to. While you’re learning them, notice how most of them are composed of the basic vertical and calendar spreads.

Up first: strategies designed for a high-volatility market environment. As you review them, keep in mind that there are no guarantees with these strategies. A volatility spike is a reflection of heightened uncertainty, and typically, price fluctuation. 

6 Strategies for High-Volatility Markets

Typically, high vol means higher out-of-the-money (OTM) option prices, which you can try to take advantage of with short premium strategies. High vol lets you find option strikes that are further OTM, which may offer high probabilities of expiring worthless and potentially higher returns on capital. Pushing short options further OTM also means that strategies have more room for the stock price to move against them before they begin to lose money. Here are a few bullish, bearish, and neutral strategies designed for high-volatility scenarios.

Bullish Strategy No. 1: Short Naked Put 

STRUCTURE: Sell put

CAPITAL REQUIREMENT: higher

RISK: Technically defined, but very high, depending on stock price

Consider looking for OTM options that have a high probability of expiring worthless and high return on capital. Capital requirements are higher for high-priced stocks, lower for low-priced stocks. Account size may determine whether you can do the trade or not. You can look for expiration in the short premium “sweet spot” around 30 to 40 days out to help balance growing positive time decay with still-high extrinsic value. Choose a stock you’re comfortable owning if the stock drops and short put is assigned. If that happens, you might want to consider selling calls against long stock to reduce cost basis further.

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Bullish Strategy No. 2: Short OTM Put Vertical

STRUCTURE: Sell put, buy lower-strike put of same expiration.

CAPITAL REQUIREMENT: lower, depends on difference between strikes

RISK: defined

Consider using when the capital requirement of short put is too high for your account, or if defined risk is preferred. Target credit for short vertical 30% of width of strikes (i.e. $0.30 if the strikes are $1 apart). Consider looking for expiration in the short premium “sweet spot” around 30 to 40 days out. Create by looking for OTM put that has high probability of expiring worthless, then look at buying further OTM put to try to get target credit, typically one or two more strikes OTM.

Bearish Strategy No. 1: Short OTM Call Vertical

STRUCTURE: Sell call, buy higher-strike call of same expiration

CAPITAL REQUIREMENT: lower, depends on difference between strikes

RISK: defined

Target the credit of the trade at 30% of the difference between strikes (i.e. $0.30 if the strikes are $1 apart). Consider looking for expiration in the “sweet spot” around 30 to 40 days out. Create by looking for OTM call that has high probability of expiring worthless, then look at buying further OTM call to try to get target credit, typically one or two more strikes OTM. Takes advantage of flatter vol skew on upside strikes.

Bearish Strategy No. 2: Long Unbalanced Call Butterfly

STRUCTURE: Sell lower-strike put vertical, sell higher-strike call vertical; distance between long and short strikes same

CAPITAL REQUIREMENT: lower, depends on difference between strikes

RISK: defined

Target the credit of the trade at 35% of the difference between long and short strikes. Look for expiration in the short premium “sweet spot” around 30 to 40 days out to balance growing positive time decay with still-high extrinsic value. Higher vol lets you find further OTM calls and puts that have high probability of expiring worthless but with high premium. Create iron condor by buying further OTM options, usually one or two strikes. Don’t do for too-small credit no matter how high the probability because commissions on 4 legs can eat up most of potential profit.

Neutral Strategy No. 2: Long ATM Call or Put Butterfly

STRUCTURE: buy 1 lower-strike option, sell 2 higher-strike options, buy 1 higher-strike option; all calls or puts, all strikes equidistant

CAPITAL REQUIREMENT: lower

RISK: defined

Max profit is achieved if stock is at short middle strike at expiration. Can place short middle strike slightly OTM to get slight directional bias. Probability of profit usually under 50% due to narrow profit range of long butterfly. High volatility keeps value of ATM butterflies lower. Butterflies expand in value most rapidly approaching expiration, so look at options 14 to 21 days to expiration. Short gamma increases dramatically at expiration (i.e., increases the magnitude of the options change in value) if the stock is at the short strike. Consider taking profit—if available—ahead of expiration to avoid butterfly turning into loser from last-minute price swing.

Let's face it; periods of high volatility can be unsettling. After all, volatility is related to uncertainty, and, where money is concerned, uncertainty can be unpleasant. But if volatility has you feeling like you've been handed a bag of lemons, experienced options traders can consider these strategies as a way to try and make some lemonade. 

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