Ask a Broker
ISSUE 703 | MAR 2008
Q: Can I play market volatility to my advantage?
A: Lind Plus Senior Market Strategist Thomas J. Mikulski answers.
The markets have been extremely volatile as of late, and we are seeing large ranges because of it. You may be tempted to stand aside when a market is in this state (and that might be your wisest choice at times), but there are strategies you can consider to take advantage of this volatility.
Something to consider is what volatility does to option premiums. When the market is volatile, the vega of the option rises, increasing its value temporarily. A good example of this can be found in the crude oil market—where this dynamic could not be truer right now. Vega is a measure of the change of the value of the option due to a 1 percent change in implied volatility, and it is a positive number for both calls and puts. Implied volatility is the volatility people think will happen between now and expiration, not what happened in the past. As implied volatility increases, the value of both calls and puts increase. If market participants are expecting large price swings, the chances of any option finishing in-the-money would increase, so the value should increase too.
So, what type of strategy can we consider to cope with this volatility? One strategy I have been recommending is a strangle. Crude oil's recent action has presented a great opportunity to sell short a May crude oil option strangle. For example, selling the May crude oil 128 call and the 86 put strangle at a premium of 90 cents (you'd collect $900 premium at expiration). Short options can be a risky strategy, because you are collecting a set premium while taking on an unlimited amount of risk. When you buy options, you pay a set premium and cannot lose more than that premium, but when you sell options you collect a set premium but the potential risk is unlimited. So, safety over greed is key in this type of strategy. You must use these strategies only when the ideal market environment presents itself, and I think conditions right now are right. There are still some decent premiums available at higher, out-of-the-money strikes at the current time due to volatility. You can apply this type of strategy to other volatile markets too—not just crude oil.
If you are not familiar with this type of strategy and would like more information, please do not hesitate to call me and we can work out a customized plan.
Thomas J. Mikulski is a Senior Market Strategist with Lind Plus, Lind-Waldock's broker-assisted division. He can be reached at 800-643-4455 or via email at tmikulski@lind-waldock.com.
Kristina Zurla Landgraf is editor of Lind eWire. She can be reached by email at editor@lind-waldock.com.
Futures trading involves substantial risk of loss and is not suitable for all investors.
Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.
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