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Chapter 26 — Volatile Options Strategies
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Volatile Options Strategies

Profiting from volatility can be difficult to understand. As a stock investor you often think of volatility as a bad thing that should be avoided, but if you predict that volatility will happen then you can use volatile options strategies to profit. Instead of seeing potential volatility and simply trying to avoid losing money from volatility, you can be active in your portfolio management and make money from volatility.

i. Long Straddle

A straddle is an options strategy where the options trader holds a position in both a call and a put with the same at the money strike price and the same expiration date. You can use this strategy when there is expected to be a huge move in the stock’s price, but you aren’t certain which direction the stock will move. Some examples of this situation are when a company faces a pending court verdict or drug approval.

A straddle trade provides unlimited potential profit and a limited amount of potential loss. The benefit of this trade is that it will give you a large profit whether the stock moves up or down. However, you will lose money if the price movement is not large enough or if you attempt the strategy during a period of high volatility. The commissions involved in this transaction can also be very high.

If you want to be an aggressive trader and the underlying stock has already made a large move in one direction, you can buy more of the corresponding options to profit from the momentum.

ii. Long Strangle

The long strangle is a variation of the long straddle and is used for the same reasons, but is less expensive to execute. It is similar to the straddle because an options trader buys a call and a put with the same expiration date but it is different than the straddle because the options have different out of the money strike prices. Buying out of the money options is cheaper than buying them at the money, making this strategy cheaper than the straddle.

The long strangle strategy has a lower amount of maximum losses than the straddle, but the price movements must be much larger (there must be higher volatility) to make the same amount of money. If the price of the security does not move outside the range between the call and the put, you will lose money on the trade, but only the amount of your original investment. Potential profits are unlimited.