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Trading Stock Option Volatility

How to Increase Your Chances of Profiting from Market Swings

Ever wonder how people make money in stock options irrelevant of the move of the underlying stock? Volatility is the answer. This is the overall market’s impression of where the stock may be going. But it doesn’t matter which way the stock is going to move (after all, no one can predict stock market fluctuation). This is why volatility is so important in stock options. This article presents some basic ideas of how you can benefit from options volatility trading.

First of all, you need to pay attention to a volatility indicator, one that will give you an idea of what people think about the stock. For example, many people use $VIX, the volatility of the S&P 500. This is an excellent indicator for all types of traders, novice and professional. If the $VIX graph is showing rapid changes throughout the day, it means volatility is high, and option premiums will rise, indicating that you should be selling options rather than buying.

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Options calculators are another great way to get a sense of the true value of an option. Generally, you will find that these calculators will give you different answers for implied volatility, delta, theta, etc. from those listed on major financial websites. If one of these calculators gives you a dramatic difference in numbers, you will want to further investigate because this difference is where the opportunity lies, and where many arbitrageurs take advantage of under-priced options.

Lastly, pay attention to open interest and volume. If open interest is high, but volume is low, you may want to stay away from those options unless you know what you’re doing. Typically, when option trading volume and open interest are close in value, it indicates that activity was high for that particular option, and could mean something bigger is going to happen, such as positive (or negative) earnings results, news that will shake the stock, etc. Remember, market makers and professional fund managers are trading options as well, so if the volume and open interest on an option are close, chances are they know something you don’t.

While options volatility trading can be technically overwhelming, with today’s availability of information on the Internet, it can minimize the time needed to do your own analysis. As always, if you believe in the stock, go with your gut feeling. And don’t forget to consistently update your information.

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