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Options Strategies For Volatility Trading In Boston’s Forex Market – Gordon is an author (Invest to Win), consultant, trader and trading coach. He has been an active investor and has provided education to individual traders and investors for over 20 years. He was the CEO of the CMT Association for 5 years and has worked at organizations including Agora, Investopedia, TD Ameritrade, Forbes, Nasdaq.com and IBM. He was also an adjunct instructor at BYU.
Jessie Moore has been writing professionally for almost two decades; for the last seven years she has focused on writing, ghostwriting and editing in the financial field. She is a Today Show and Publisher’s Weekly contributor who has written more than 10 books on topics ranging from day trading to unicorns to plant care.
Options Strategies For Volatility Trading In Boston’s Forex Market
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When you’re buying a big ticket, you’re probably shopping around. You don’t want to buy something when you can find a better price elsewhere. On the other hand, you don’t want to sell at a discount if someone is willing to pay full price.
There are times when option prices are inflated and other times when they are deflated. As an options trader, it is important to be able to distinguish between these two situations.
Keep reading for the ultimate options education on implied volatility, including how this calculation helps you make better decisions when buying and selling options.
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Implied volatility is a metric that investors use to estimate a security’s price fluctuation (volatility) in the future and causes option prices to inflate or deflate as demand changes.
You see, the market value of an option is determined in part by the change in demand for that option. This is the driving force behind implied volatility.
Over time, the price of a security fluctuates and an average price can be determined. Once the mean is calculated, traders can track the security’s price to see how much the price moves above or below its mean value – thus measuring volatility.
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While historical volatility informs a trader how much a security’s price has moved in the past, implied volatility is used to help traders determine how much a security’s price might move in the future.
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To continue our discussion of what implied option volatility is, let’s look at historical volatility, which shows how much a security’s price has moved in the past and how much the security’s price might move in the future as demand changes.
Demand can lead to inflation and deflation in option prices, but it is up to the options trader to recognize their occurrence.
To better understand the effects of implied option volatility, consider a baker. A baker can sell cookies for $3 and has several people knocking on their door.
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However, the next time the baker opens the door, there is a long line of customers clamoring for cookies – demand has skyrocketed.
With additional demand, the baker raises the price to $4. After the time passed, something happened… Now, the baker only has one person a day who wants cookies – the demand has dropped.
The effects of implied volatility are similar. With high demand, option prices rise. When demand decreases, option prices may decrease. (But no, you don’t get a cookie.)
Next, let’s discuss the use of implied volatility to estimate the range of future price movement of the underlying security.
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Implied volatility can be used to estimate the price range of a security in the future. All you have to do is add a call and combine the premiums.
Look at the money call and put options for guidance. To find out-of-the-money options, look at the security’s current market value and then find the option price that is closest to that.
For the first step, if the stock is trading at $90.50, the $90 strike price would be an out-of-the-money contract.
Then, in the second step we will assume that the $90 call trades for $3.50 and the $90 put trades for $3.00. The combined call and put value is $6.50.
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Finally, for the third step, we will take the stock price, $90.50, and add and subtract $6.50 to assume the stock’s expected range expiration. In this case, the range is between $97 and $84, or $13.
The figure below illustrates Apple’s August 4 option expiration and the associated implied volatility percentages, along with the security’s expected price ranges, indicated in parentheses.
Online brokers that cater to options traders will usually have implied volatility available in their trading software, so be sure to ask if this feature is available to you as a potential client.
Let’s move on to discuss two common models (calculators) that traders can use to calculate potential option returns using implied volatility.
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To determine how to find the implied volatility of a stock, in 1973 the Fischer Black, Robert Merton and Myron Scholes calculator was developed. Known as Black-Scholes, the calculator was used to calculate theoretical option values using five variables:
While it is not necessary to use these implied volatility calculators, having access to one through your broker would allow you to run what-if scenarios in options trading.
The Black-Scholes model is used to price European-style options. However, most stocks and exchange-traded funds offer American-style options – weekly-expiring options. In indices like the S&P 500, you’ll find European-style options.
The binomial model is designed to calculate the implied volatility of a stock and how much an option could be worth given changes in price, time and volatility.
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Weekly options can be exercised at any time (American style), so whether you are trading American or European style options, the binomial model can be used.
As you learn more about implied volatility, the question is bound to arise – “What amount of implied volatility is good?”
Because implied volatility levels differ between strike prices and securities, you won’t find a static value to use as a benchmark, but you can look at past implied volatility levels for guidance.
To illustrate, let’s look at a chart called “The VIX”. In the image below, you will see a quarterly representation of the Broad Market Volatility Index – VIX.
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The red lines on the chart indicate the high, low and medium volatility ranges over the three-month period.
Using the VIX is an easy way to determine where general levels of market volatility have been over time and whether the current level of volatility, shown on the right, is high or low relative to the past.
You’ll notice that the current level indicates that volatility is roughly in the mid-range, but rising. Use the VIX as a quick guide to identify high or low levels of volatility.
Higher levels of implied volatility may imply less certainty in the direction and magnitude of stock price movements.
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Option sellers may be forced to sell option contracts for longer periods to obtain adequate option premiums, leading to riskier trading
Implied volatility also fluctuates regularly in equity options. Events such as FDA announcements or semiconductor supply issues can affect demand for single-stock options.
Changes in volatility can cause the option buyer to lose money even if the security is moving favorably. Not recognizing the implications of implied volatility can be a hard lesson for any trader.
We can’t go into exhaustive detail on this list right now (we think we do that on our top options trading platform), but let’s at least look at my top pick: eToro.
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First, the fees. With $0 per contract and a minimum account of $50, options trading is accessible to almost anyone on the platform.
It also has some very unique features, eToro CopyTrader, which allows you to follow and copy the trades of experienced traders, perfect for new investors who are still learning and want to see how others trade.
Each trader has a profile with a rating, performance history, risk profile and more so you can easily compare the best traders and find the ones that best suit your goals.
In short, eTorois is a great choice for beginner and intermediate options traders looking for an affordable copycat platform.
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