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 this means is that there are usually plenty of opportunities to make profits through using volatile options trading strategies. On this page, we look at the concept of such strategies in more detail and provide a comprehensive list of strategies in this category.
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.
Of course, this isn't without its risks. If the price of the underlying security goes up, but not by enough to make the long call profits greater than the long put losses, then you'll lose money. Equally, if the price of the underlying security goes down, but not by enough so the long put profits are greater than the long call losses, then you will also lose money.
Basically, small price moves aren't enough to make profits from this, or any other, volatile strategy. To reiterate, strategies of this type should only be used when you are expecting an underlying security to move significantly in price.
List of Volatile Options Trading Strategies
Below is a list of the volatile options trading strategies that are most commonly used by options traders. We have included some very basic information about each one here, but you can get more details by clicking on the relevant link. If you require some extra assistance in choosing which one to use and when, you may find our Selection Tool useful.
Long Straddle
We have briefly discussed the long straddle above. It's one of the simplest volatile strategies and perfectly suitable for beginners. Two transactions are involved and it creates a debit spread.
Long Strangle
This is a very similar strategy to the long straddle, but has a lower upfront cost. It's also suitable for beginners.
Strip Straddle
This is best used when your outlook is volatile but you think a fall in price is the most likely. It's simple, involves two transactions to create a debit spread, and is suitable for beginners.
Strip Strangle
This is basically a cheaper alternative to the strip straddle. It also involves two transactions and is well suited for beginners.
Strap Straddle
You would use this when your outlook is volatile but you believe that a rise in price is the most likely. It is another simple strategy that is suitable for beginners.
Strap Strangle
The strap strangle is essentially a lower cost alternative to the strap saddle. This simple strategy involves two transactions and is suitable for beginners.
Long Gut
This is a simple, but relatively expensive, strategy that is suitable for beginners. Two transactions are involved to create a debit spread.
Call Ratio Backspread
This more complicated strategy is suitable for when your outlook is volatile but you think a price rise is more likely than a price fall. Two transactions are used to create a credit spread and it is not recommended for beginners.
Put Ratio Backspread
This is a slightly complex strategy that you would use if your outlook is volatile but you favour a price fall over a price rise. A credit spread is created using two transactions and it is not suitable for beginners.
Short Calendar Call Spread
This is an advanced strategy that involves two transactions. It creates a credit spread and is not recommended for beginners.
Short Calendar Put Spread
This is an advanced strategy that is not suitable for beginners. It involves two transactions and creates a credit spread.
Short Butterfly Spread
This complex strategy involves three transactions and creates a credit spread. It isn't suitable for beginners.
Short Condor Spread
This advanced strategy involves four transactions. A credit spread is created and it isn't suitable for beginners.
Short Albatross Spread
This is a complex trading strategy that involves four transactions to create a credit spread. It isn't recommended for beginners.
Reverse Iron Butterfly Spread
There are four transactions involved in this, which create a debit spread. It's complex and not recommended for beginners.
Reverse Iron Condor Spread
This advanced strategy creates a debit spread and involves four transactions. It isn't suitable for beginners.
Reverse Iron Albatross Spread
This is a complex trading strategy that is not suitable for beginners. It creates a debit spread using four transactions.
