How do I Trade Options in Volatile Markets Using Optionetics?

You can trade a volatile stock market using options.

Stock options are complex financial instruments that offer trading techniques unavailable through the buying and selling of actual stock. Stock options trade on the public markets and nearly anyone may trade them, but they are complicated and not for the novice. If you expect particularly volatile stock market conditions, you can profit from the increased volatility using stock options. There are many strategies, some of which require considerable experience before attempting. The on line options resource Optionetics notes that "straddle" positions are one way to trade volatile markets.

Things You'll Need

• Stock option brokerage account

Instructions

1. Select a particular stock or stock market index that you expect will be volatile. Volatility is characterized by dramatic swings in prices both up and down, where there is not a clear overall trend in either direction. Options let you trade based on individual stock predictions or the overall stock market, as in the case of the Standard & Poors 500 options.

2. Select the expiration date of the options position you will initiate. All stock options eventually expire. Those that expire soon, within the next one to two months, are particularly risky, as they have limited time to achieve profitability.

3. View the "option chain" for the stock or stock market index and expiration date you selected. The option chain is simply the list of available options. You can view this information in all option trading platforms. You can also see this on some investment research websites (see Resources).

4. Locate the stock's current price in the option chain's "strike price" list. All stock options have a "strike price" which affects how their value changes with respect to the underlying stock or stock market index.

5. Buy one "call" option and one "put" option at the strike price that is equal to the stock's current price. For example, if you expect a stock with ticker "ABC" to be volatile and it is currently priced at $100 per share, buy an equal number of call options and put options with strike prices nearest $100.

6. Sell both the calls and the puts once the position experiences an overall net profit. This will occur if the stock moves sharply either up or down in price.

Tips & Warnings

• Calls and puts are the two types of stock options. A call rises in value as the stock rises, while a put rises in value as the stock declines. This position will become profitable in highly volatile market conditions, regardless of the actual direction of a price swing. One of the two "legs" (either the calls or the puts) of the position will dramatically increase in value, overwhelming the loss from the other leg.

• Sign up for a free Optionetics account to access the details of many stock option strategies and educational resources. Only limited information is available to non-registered members of the Optionetics website.

• Stock options are highly volatile and risky financial investments. You should minimize the capital you commit to stock option trades until you gain lots of experience with option strategies.

References

• Optionetics: Using Volatility to Select Option Strategies
• Power Options: Long Straddles

Resources

• Schaeffer's Investment Research, Inc.: Option Quote