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Volatility and Holiday Season: Will Vol Show Up to Party?

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September 28, 2016
volatility holiday season
Fredrik Broden

Holiday season is approaching and even though there are only a few days when the markets are closed, traders often take time off around them. This can lead to lower holiday trading activity, which can mean larger swings in stocks.

The more active traders there are in the markets, the more buyers are available when an institution needs to sell a large block of stock, or sellers available when a big hedge fund wants to buy. More traders can also mean a higher possibility of executing buy and sell orders closer to a listed price. With fewer buyers, fewer people are willing to trade at prevailing prices, may only sell at higher prices, or may buy at lower prices.

A large buy order, then, might drive the price of a stock or future up dramatically. That’s why trading around the holidays can be tricky. But you can get some practice dealing with lower trading activity before the holidays.

Overnight markets often have similar liquidity and price-movement issues as holiday activity. Why? Fewer traders at their screens means overnight markets can have larger price movements than you might see during regular trading hours. The difference is big moves in low-activity holiday markets can likewise happen during regular trading hours.

Grab your coffee, log in to the thinkorswim® platform by TD Ameritrade, and go to the Chart page. Watch the prices of stocks and futures change overnight. The trades are often more sporadic and have bigger jumps in price compared to the more continuous stream of trades under cover of daylight. You don’t have to trade overnight to see that it can be a bit trickier when the moon rises and werewolves are shorting.

Drawing some insights from overnight trading, keep three things in mind that can help you manage the holiday swarm:

1. Keep positions small. A good idea any time of year. But around the holidays, it can mean the difference between a small loss and a huge one. If a stock drops $2, the loss on long 100 shares is five times smaller than 500 shares. And smaller orders can mean faster executions and lower slippage when holiday trading volume is lighter.

2. Define your risk. Yes, light volume can drive larger price moves. But that doesn’t mean the profit/loss caused by such a move isn’t real. Defining your risk—using verticals instead of naked short options, or iron condors instead of short strangles—can mean you enjoy that bloated holiday party feeling without worrying about the market.

3. Monitor implied vol. The holiday drops in stock liquidity and trading activity are exacerbated in the options markets. So keep an eye on implied volatility for signs the market may anticipate less activity, which can drive implied vol lower. If nothing happens, lower implied vol is justified, and no one is surprised. But if something shocks the market and it springs to life, implied vol around options can spike higher, while the bid/ask spreads widen out. Even if you think higher implied vol presents a trading opportunity, you might have to work limit orders in between wider bid/ask spreads to reduce slippage.