Profiting from Increased Market Volatility
Profiting from Increased Market Volatility
By:Kai Zeng
Strategies to boost profits while reducing risk in times of wildly varying stock prices
Recently, we've observed a surge in market volatility. The rapid increase in prices presents excellent opportunities for options sellers, who can pursue either of two goal—to collect more premium or to maintain the same premium while reducing risk.
Strategies to collect more premium
1. Increase position sizes
Instead of sticking to risk-defined trades, for example, traders could consider selling naked positions. Premiums tend to increase much more in strangles than in iron condors.
However, we found that widening the wings of an iron condor doesn’t necessarily lead to much higher premiums—the difference remains negligible.
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2. Sell neutral positions
Rather than focusing on puts, traders can sell neutral positions to collect more premium while improving downside protection. Some might fear a market rally could negatively impact their short call positions. However, a short call may not incur a loss as the market rises after a sharp decline because implied volatility can decrease rapidly enough to cause a positive change in vega to offset the adverse delta impact.
For example, between Aug. 5 and Aug. 8, the SPDR S&P 500 ETF (SPY) rallied by 3%. Despite this, the call option sold on Aug. 5 remained profitable because of the significant drop in implied volatility.
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Strategies to maintain premium while reducing risk
1. Use strikes that are farther away
Traders can collect the same premium by selling strikes that are farther away. For instance, selling a 16 delta (Δ) strangle on Aug. 5 can generate the same premium as selling a 20Δ strangle on Aug. 8. Additionally, the strikes of the 16Δ strangle are $40 wider, offering a significantly higher probability of success.
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2. Use shorter-duration options
On Aug. 8, the premium for a 71-day days to expiration (DTE) 16Δ strangle was $8.40. To achieve a similar probability of profit and premium, traders could reduce the duration to less than half of that on Aug. 5, thus maximizing potential return on capital (ROC) in the same timeframe.
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Takeaways
- When implied volatility is higher, options traders have more opportunities to enhance potential returns by collecting richer premiums using the same strategies.
- For risk-averse investors, various methods help maintain return on capital while achieving a higher probability of profit or reducing risk.
Kai Zeng, director of the research team and head of Chinese content at tastylive, has 20 years of experience in markets and derivatives trading. He cohosts several live shows, including From Theory to Practice and Building Blocks. @kai_zeng1
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