Advanced Options Trading Strategies
When learning about options, most traders start out by using the long call and long put strategies. While these can be very profitable strategies to use over time, traders are barely scratching the surface of how powerful options can be. As long as you have a system in place that will pick direction consistently then you will be ok with long calls and puts. However, we all know that the market isn’t always moving. We will go through stretches when the market does nothing but go sideways. As a trader I still want to have ways to scratch out a profit during these times. The great part about options is that we can use strategies that thrive in quiet market conditions. Let’s take a look at how this is done.
Options have many different variables that go into the pricing model. Yes, market direction plays a large role in how the prices change over time. However, if we can also take advantage of changes to some of the other inputs in the pricing model then we open up more windows of opportunity. This is done by placing non-directional trades or trades that really don’t focus solely on market direction. For example, we know that options are decaying assets. They lose some value each day they are held which is known as time decay. If we know that options lose value each day they are held then why not put on a trade that takes advantage of this. We can do this by selling options to open a position. This will allow us to profit from nothing else changing but the passing of time.
A second input in the options pricing model that we can take advantage of is Implied Volatility. In fact, this is the most important factor that affects the pricing of an option. We want to make sure the options strategy that we are using matches up with that product’s current level of volatility. Implied volatility doesn’t like to stay at extreme high or low levels for very long. If we can take advantage of knowing whether these levels are high or low, then we can use strategies that will increase our odds of success. When implied volatility is high options are more expensive. With this in mind we would rather sell options to take advantage of the higher prices. In this case, we would benefit from volatility moving back to an average level. On the flipside, if implied volatility is low then than the options are cheap. We would rather buy options in order to take advantage of the cheap prices with the anticipation of implied volatility rising. This would also lead to the option prices going up. It is important to keep track of levels of volatility on each product that you trade over time. This way you will know if it is high or low for that given product. Keeping note of these volatility levels in a trade journal has been very helpful for many traders.
Some of the strategies that we can use to take advantage of the passing of time and changes in implied volatility include, Short Call and Put Spreads, Iron Condors, Calendars and Butterflies.
These types of trades combine buying and selling options to put on a hedged position that actually gives you the opportunity to profit from nothing else changing other than the passing of time and or a change in the level of implied volatility. Some people might look at this and say why would I not place these types of trades all the time? The key to remember is that you want to use strategies that match up with your market outlook. If you are very bullish or bearish then you will want to use other directional strategies that will give you higher returns. Non-directional trades like Iron Condors and Calendars are great because they give you the chance to profit if the stock moves in your direction or goes straight sideways but they also will produce smaller returns. If you are ok with this trade off then they are great strategies to use.