Options trading has two big advantages over almost every other form of trading. One is the ability to generate profits when you predict a financial instrument will be relatively stable in price, and the second is the ability to make money when you believe that a financial instrument is volatile.
When a stock or another security is volatile it means that a large price swing is likely, but it’s difficult to predict in which direction. By using volatile options trading strategies, it’s possible to make trades where you will profit providing an underlying security moves significantly in price, regardless of which direction it moves in.
There are many scenarios that can lead to a financial instrument being volatile. For example, a company may be about to release its financial reports or announce some other big news, either of which probably lead to its stock being volatile. Rumors of an impending takeover could have the same effect.
What are Volatile Options Trading Strategies?
Quite simply, volatile options trading strategies are designed specifically to make profits from stocks or other securities that are likely to experience a dramatic price movement, without having to predict in which direction that price movement will be. Given that making a judgment about which direction the price of a volatile security will move in is very difficult, it’s clear why such they can be useful.
There are also known as dual directional strategies, because they can make profits from price movements in either direction. The basic principle of using them is that you combine multiple positions that have unlimited potential profits but limited losses so that you will make a profit providing the underlying security moves far in enough in one direction or the other.
The simplest example of this in practice is the long straddle, which combines buying an equal amount of call options and put options on the same underlying security with the same strike price.
Buying call options (a long call) has limited losses, the amount you spend on them, but unlimited potential gains as you can make as much as price of the underlying security goes up by. Buying put options (a long put) also has limited losses and almost unlimited gains. The potential gains are limited only by the amount which the price of the underlying security can fall by (i.e. its full value).
By combining these two positions together into one overall position, you should make a return whichever direction the underlying security moves in. The idea is that if the underlying security goes up, you make more profit from the long call than you lose from the long put. If the underlying security goes down, then you make more profit from the long put than you lose from the long call.
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