When volatility falls, many option traders turn to these five strategies designed to capitalize on depressed volatility levels.
The stock market ebbs and flows—not just in price, but also in volume and magnitude. Some periods are highly volatile, with lots of price action and price fluctuation. Some would call these markets exciting, while others would call them nerve-racking. Several options strategies are designed for such volatile trading environments.
Other periods are quite the opposite. When volatility is low, things can seem dull. Stuck in the mud. In the doldrums. Think holiday markets and the dog days of summer rolled into one. Some options strategies are designed for such markets. But before we continue, a note of caution: there are no guarantees with these or any trading strategies. When options prices are relatively cheap, it’s typically a reflection of low price action and market calm.
Lower vol usually means lower options premiums. That can make credit strategies (those in which premium is collected up front) less attractive—but all debit strategies are not created equal. Forget about straight long options for the moment. You might look for debit strategies where time decay is positive (i.e., time decay is working for, not against, your trade). Keep position sizes small. Add duration to strategies with a deferred expiration date to give the underlying stock some time to move in favor of the strategy.
Here are five options strategy ideas designed for lower-volatility environments: two bullish, two bearish, and one neutral. So wake up, grab a cup of coffee, and let's take a look.
Consider creating a vertical where the debit is less than the intrinsic value of the long call. That will make the time decay, or theta, positive for this debit position. Consider looking at expiration dates 30 to 60 days out to give the position more duration. Max profit is usually achieved close to expiration or if the vertical becomes deep ITM. Consider taking less than the max profit ahead of expiration if available.
Because calendar spreads maximize their value when the stock is at the calendar’s strike price near expiration, this bullish strategy has an “up to this price, but not much more” bias. Lower vol can make calendar debits lower. One strategy is to look for a short option between 25 and 40 days to expiration and a long option between 50 and 90 days to expiration. Consider looking for a calendar that can be profitable if the stock stays at its current price through the expiration of the front-month option, and has approximately 1.5 times the debit price for max profit if the stock is at the strike price at expiration.
You can create vertical spreads where the debit is less than the intrinsic value of the long put. That should make the time decay positive for this debit position. Consider looking at expiration dates 30 to 60 days out to give the position more duration. Max profit is usually achieved close to expiration or if the vertical becomes deep ITM. Consider taking less than the max profit ahead of expiration if it’s available.
Because calendars maximize their value when the stock is at the calendar’s strike price near expiration, this bearish strategy has a “down to this price, but not much more” bias. Lower vol can make calendar debits lower. Put calendars can benefit from an increase in vol if it increases on a drop in the stock price. Consider looking for a short option between 25 and 40 days to expiration and a long option between 50 and 90 days to expiration. Look for a calendar that can be profitable if the stock stays at the current price through the expiration of the front-month option, and has approximately 1.5 times the debit price for max profit if the stock is at the strike price at expiration.
Shorting an ATM call and put can generate a large credit even in a low-vol environment, but it requires greater confidence that the stock price won’t change much between now and expiration. Consider selling options closer to expiration—between 20 and 35 days—to maximize positive theta. And consider buying back the short straddle before expiration if profit is available.
Let’s face it: Periods of low volatility can be, in a word, boring, especially if you’re an active trader who thrives on price action. But when low volatility rears its head, and the trading screens resemble paint drying, experienced option traders can consider these strategies as a way to seek opportunity amid the lull.
While options trading involves unique risks and is definitely not suitable for everyone, if you believe options trading fits with your risk tolerance and overall investing strategy, TD Ameritrade can help you pursue your options trading strategies with powerful trading platforms, idea generation resources, and the support you need.
Learn more about the potential benefits and risks of trading options.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2022 Charles Schwab & Co. Inc. All rights reserved.