Change text size

• Email This Article
• Print This Article
• Digg This
• Delicious
• Subscribe

When choosing an options position in the markets, the option strategist needs to closely examine current implied volatility levels as a first step toward selecting the most appropriate options strategy. Once this is done, he or she can drill down further and interject a directional bias, whether it is bearish, bullish or neutral. At this point, enough information is gathered to select a strategy. Note that these two steps can certainly be interchanged, but both need to be done to put the probabilities of success in the option strategist’s corner. This article will address the strategies available in a high implied volatility environment.  

People who are just starting out in the options market often steer away from high-volatility stocks, deeming them way too risky. However, when these types of environments are properly understood, a variety of low risk and high reward strategies can be employed. One of the reasons why high-implied volatility markets are probably avoided by beginners is that many times they are associated with selling naked calls and selling naked puts, which, of course, can be a very risky endeavor and are never recommended by Optionetics.

As with low volatility stocks, when option strategists are trading high volatility stocks they are betting that eventually there will be a reversion to the mean. For example, when a stock is very quiet with low levels of volatility, traders become less active and do not expect anything to happen. Many times this is when the stock explodes. On the other hand, when an equity option contract has been really active and showing levels of high implied volatility for a period of time, traders are usually already in the stock and anticipating volatility to remain high.

The result of this behavior is that the option is most likely to maintain a wide range for some time. However, thanks to the reversion to the mean concept, that pattern will not go on indefinitely. The advantage to the option strategist compared to the pure stock trader is that this pattern of high and low volatility is much easier to recognize and forecast. Now let’s examine some of the lower risk option strategies that can be implemented in a high-implied volatility environment.

The way to take advantage of high-implied volatility is to use spread strategies when wanting to be a net seller of premium. For instance, if bullish, some of the combination option strategies that can be used are the bull put spread and buying the in-the-money put butterfly. If the option strategist possesses a bearish bias, then strategies like the bear call spread or buying an in-the-money call butterfly would be appropriate. Finally, if taking a neutral stance on the stock, then buying an at-the-money put or call butterfly or an at-the-money put or call calendar spread could be employed.

Of course, a variety of other low risk strategies can be employed on a highly volatile stock based on market outlook. A great tool to use is the options analysis package Platinum, which offers a buffet of strategies that match up with the current market volatility and the trader’s stock forecast. The point to remember is that there are plenty of low risk strategies the option strategist can use to capitalize in high-implied volatility environments where it is certainly advantageous to be a net seller of premium.

Happy Trading.


Jeff Neal
Senior Writer & Options Strategist
Optionetics.com ~ Your Options Education Site
Visit Jeff’s Forum

• Email This Article
• Print This Article
• Digg This
• Delicious
• Subscribe

Recent Articles by Jeff Neal, Optionetics.com

• December 29, 2009
  Dissecting the Basic Stock Quote Page
• December 29, 2009
  Back to Basics: Reviewing the Market Entry and Exit Orders
• June 12, 2009
  Interview Central: Mark Seleznov, Part III
• June 5, 2009
  Interview Central: Mark Seleznov, Part II
• May 29, 2009
  Interview Central: Mark Seleznov, Part I