What Are The Characteristics Of This Option Strategy?
High implied volatility option strategies buy calls and puts on the same underlying asset, at the same strike price and the same expiration, to profit from a large move in the asset without taking a side on the direction. That construction is a long straddle: the trader pays two premiums up front, and that combined debit is the most the position can lose. Traders generally use a mix of technical indicators, price action and fundamental analysis to judge whether the coming move is likely to be bigger than the one already priced into the options.
Is This A Bullish, Bearish Or Neutral Strategy?
The high implied volatility option strategy is a neutral strategy. It is executed in anticipation of future price movements without taking any directional bias.
Is This A Beginner Or An Advanced Option Strategy?
The high implied volatility option strategy is classified as an advanced option strategy. Experience and knowledge in the options market are required before using this strategy.
In What Situation Will I Use This Strategy?
The high implied volatility option strategy is used when a large move is expected in the underlying but the direction of it is not known. The distinction that matters is between realised and implied volatility: the position only pays if the asset moves more than the options already had priced in. That makes it a trade for an option chain that is still cheap ahead of an expected catalyst, or for a market where implied volatility is expected to expand, rather than one where the premium has already been bid up.
Where Does This Strategy Typically Fall In The Range Of Risk-Reward And Probability Of Profit?
The high implied volatility option strategy sits in the high risk, high reward range with a low probability of profit. Because two premiums are paid, the stock has to travel further than either strike before the position breaks even, and the most likely single outcome for any given expiration is that it does not get there. The loss is defined and cannot exceed the debit paid, and the position loses money whenever the underlying finishes between the two breakevens, which is most of the time. The entire debit is only gone if the underlying finishes right at the strike; between the strike and a breakeven part of it comes back.
How Is This Strategy Affected By The Greeks?
Options strategies are affected by the four main greeks – Delta, Gamma, Vega, and Theta. The high implied volatility option strategy is affected primarily by Vega. Vega represents the rate at which the value of an option contract changes due to a 1% change in implied volatility. Because the position buys two options it is long vega, so it gains if implied volatility expands after the trade is opened and loses if implied volatility contracts. It is also short theta: the position pays decay every day, and that decay accelerates as expiration approaches, so vega and theta pull against each other for as long as the trade is held.
In What Volatility Regime (I.E VIX Level) Would This Strategy Be Optimal?
Because the position is long premium and long vega, it works best when implied volatility is low and expected to expand. Buying it after implied volatility has already spiked means paying an inflated premium that is likely to be crushed once the event passes.
How Do I Adjust This Strategy When The Trade Goes Against Me? And How Easy Or Difficult Is This Strategy To Adjust?
The mechanics of adjusting are simple, but the options are limited and none of them are free. Rolling to a different strike or expiration takes advantage of a different implied volatility environment, and selling a further out-of-the-money call and put against the position turns it into an iron butterfly that reduces the daily bleed. Both cost money or cap the upside. The one thing that cannot be adjusted away is time: every day the underlying fails to move, the position is worth less, and there is no repair that reverses decay already paid.
Where Does This Strategy Typically Fall In The Range Of Commissions And Fees?
The high implied volatility option strategy typically falls in the higher range of commission and fees. This is because the strategy generally involves buying and selling both calls and puts, which increases the costs associated with executing the strategy.
Is This A Good Option Income Strategy?
No. This is a debit strategy, not an income strategy. It pays premium out rather than collecting it, and time decay works against it every day the position is held. There is no guarantee of profits, and the entire debit paid can be lost.
How Do I Know When To Exit This Strategy?
It is important to monitor the implied volatilities of the underlying asset to determine when it is time to exit this strategy. Because the position is long vega, a fall in implied volatility works against it. Take profits after implied volatility has expanded or the underlying has made its move, and cut the position when volatility contracts without the expected move happening.
How Will Market Makers Respond To This Trade Being Opened?
Market makers will generally not respond to this trade being opened. This strategy generally does not involve the market maker taking a directional bias and therefore they will not intervene.
What Is An Example (With Calculations) Of This Strategy?
Here’s an example of the High Implied Volatility Option Strategy using the stock MSFT, which is trading at $285:
Assuming that we expect MSFT’s price to experience a significant move in the near future due to high implied volatility, we could use the High Implied Volatility Option Strategy to profit from this. In this case, we could set up the following trade:
Buy 1 MSFT call option with a strike price of $285 for a premium of $10.00
Buy 1 MSFT put option with a strike price of $285 for a premium of $8.00
The total cost of this trade is $18.00 per share, or $1,800 for one contract of each. That debit is the maximum potential loss, and it is lost in full only if MSFT finishes exactly at $285.
The breakevens are the two strikes adjusted by the debit paid: $285 plus $18.00 is $303 on the upside, and $285 minus $18.00 is $267 on the downside. MSFT has to close outside that band for the trade to make anything at all.
Above $303 the profit is theoretically unlimited, growing dollar for dollar with the stock. Below $267 the profit grows too, but it is bounded, because the stock cannot fall past zero; the best case on the downside is $267 per share ($26,700).
If MSFT’s price stays around $285, both options expire worthless and we lose the entire $1,800. Being in the money is not the same as being profitable: at $295 the call is worth $10.00 and the put is worthless, so the position is worth $10.00 against the $18.00 paid and is still down $8.00 per share. The move has to be roughly 6% in either direction before this trade turns a profit, which is exactly why buying a straddle after implied volatility has already spiked is such an expensive way to be right about direction.
MarketXLS
Investors and traders looking to execute the high implied volatility option strategy can take advantage of MarketXLS’s easy-to-use trading platform and analytical tools. MarketXLS’s indicators help traders easily determine the current implied volatility of the underlying asset and allow them to track the price action of their options trades. MarketXLS also offers options trading calculators which can help traders calculate the expected profit and loss of their options trades.
Whether you are a beginner trader or an experienced trader, MarketXLS can help you create a trading strategy for the high implied volatility option strategy. With MarketXLS, you can easily track the performance of your trades, manage your risk, and increase your probability of profit.
Here are some templates that you can use to create your own models
Search for all Templates here: https://marketxls.com/templates/
Relevant blogs that you can read to learn more about the topic
Difference Between Historical And Implied Volatility
Options Trading For Beginners (Management And Tracking)
Long Call Diagonal Spread – An Advance Option Strategy
Protecting Against Implied Volatility(Long Straddle)
Introduction to High IV Options