There are many different option trading strategies to choose from, and volatility should be taken into account for all of them. That’s because as volatility changes so does the price of the underlying stock, index, or EFT. The following article does a nice job of explaining how to use volatility to your advantage while trading options.
Learning how to trade volatility is a key concept for new traders to learn when starting out in options trading. Implied volatility is one of the key pricing inputs in the Black Scholes option pricing model and while I won’t detail all the calculations now, it is based on various inputs, of which implied volatility is the most subjective (as future volatility is not known, we have to make a best guess) and therefore, gives us the greatest chance to manipulate the pricing model based on our view of volatility compared to that of other traders.
One of the keys to learning how to trade volatility is learning how changes in implied volatility will affect the different option trading strategies. While, you don’t need to master all the advanced topics on volatility (and there are a lot), a good basic understanding will go a long way towards helping you become successful.
Option implied volatility is shown by the Greek symbol Vega which is expressed as the total that the price of an option will change in response to a 1% change in implied volatility. To put it another way, an options Vega is a measure of the responsiveness of an options price to changes in the volatility of an underlying asset. All else being equal (no movement in share price, interest rates and no passage of time), option prices will rise if there is a rise in volatility and fall if there is a fall in volatility.
As such, it makes sense that buyers of options (such as being long either calls or puts), will gain from rising implied volatility and sellers will gain from falls in implied volatility. The same can be said for spread traders. For example, Bull Call spreads will benefit from rising volatility while Bull Put Spreads (you are a net seller of options with this trade) will benefit from falling volatility.
Option volatility incorporates any events that are known to occur throughout the life of the option that could have an impact on the movement of the underlying stock. Examples could be an earnings release or the results of a drug trial for a pharmaceutical conglomerate.
The mood of the general market is also included in volatility estimates for individual stocks. If markets are subdued, volatility estimates are small, but when markets undergo corrections or violent moves, volatility estimates will be hiked. An easy method of watching the general levels of market volatility is to monitor the VIX Index, ticker symbol VIX. This will tell you how market participants view the current levels of volatility.
The below information shows which strategies will benefit from a rise in volatility and which will benefit from a fall in volatility
BENEFIT FROM AN INCREASE IN IMPLIED VOLATILITY
Long Call
Long Put
Long Straddle
Long Strangle
Bull Call Spread
Bear Put Spread
Short Iron Condor
Short Butterfly
Ratio Backspreads
BENEFIT FROM A DECREASE IN IMPLIED VOLATILITY
Short Call
Short Put
Short Straddle
Short Strangle
Bull Put Spread
Bear Call Spread
Long Iron Condor
Long Butterfly
Ratio Spreads
For anyone looking to get started in options trading, I strongly recommend you learn about option implied volatility and at least gain a basic understanding of how to trade volatility.
Click here for more on how to trade volatility
Using Options To Trade Volatility
by: Editor 
December 21st, 2011
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