Author: Laura Leithold
Publication date: 16.08.2023
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Options trading goes beyond traditional stock trading. It allows investors to profit from various market scenarios, regardless of price direction. In this short article, you will learn about the fundamental principles of options. Moreover, you will see how you can use high volatility to your advantage.
What are the options in options trading?
Options are derivatives that allow you to buy or sell an underlying asset. These underlying assets can include stocks, bonds, commodities, currencies, or market indexes.
In particular, there are two main types of options: call options and put options.
● A call option gives the buyer the right, but not the obligation, to buy the underlying asset at an agreed-upon price and date. An investor should buy a call option if he expects an increase in the underlying stock price (bullish market).
● A put option gives the buyer the right, but not the obligation, to sell the underlying asset at an agreed-upon price and date. An investor should buy a put option if he expects a decrease in the underlying stock price (bearish market).
Therefore, Options can be used by investors to protect against financial risk and speculation.
Neutral strategies
Sometimes it is hard to tell if the underlying stock price will increase or decrease. In this case, neutral strategies should be applied. Examples for neutral strategies are (long) straddles and (long) strangles. A profit will be achieved if the price makes a significantly large move in either direction. Therefore, these strategies are suitable for high-volatility scenarios.
Straddle Strategy
In a long straddle strategy, the options trader buys both a call option and a put option with the same strike price and expiration date. These options are at-the-money which means that the strike price is identical to the market price of the underlying security.
Advantages of long straddles
● Higher potential profit
● Requires less volatility
Strangle Strategy
In a long strangle strategy, an options trader buys both a call option and a put option, similar to the straddle. However, the strike prices are different for each option. The call option strike price is set above the current market price, while the put option strike price is set below the current market price. These options are out-of-the-money.
Advantages of long strangles
● Lower costs
● Does not require large investment
Using Volatility Index (VIX) Options and Futures
Volatility Index (VIX) options and futures are suitable for investors who want to trade volatility directly. The VIX represents the stock market's anticipation of volatility derived from S&P 500 index options. Whilst long straddles and long strangles are directly dependent on the underlying asset's volatility, VIX options and futures directly track market volatility.
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