When the Volatility Index or VIX gets above 20, most traders take their foot off the gas due to heightened uncertainty in the markets. But to options traders that sell premium, higher volatility equals more opportunity.
Let me explain why. Historically, neutral options strategies volatility IV is always greater than realized volatility. Implied volatility is just the annualized expected one standard deviation range of something.
And unlike price, volatility is mean reverting. So when implied volatility gets high, options sellers look to get more aggressive since there is a statistical edge in selling higher priced premium. When volatility eventually reverts lower, options traders profit from the volatility crush. There are many options strategies that can be used in a high IV environment. All 3 of these neutral direction options strategies have a mathematical edge when volatility is high.
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The strategies include: the short straddle, the short strangle, and the short iron condor. Strategy 1 Most Aggressive The most aggressive neutral options strategy in a high implied volatility environment is the short straddle.
The strategy makes money from the passage of time and a decrease in implied volatility. The max profit a trader can receive from the strategy is the credit collected from selling the options. The higher the credit collected, the higher the break-even points in case the underlying moves too far up or down.
Bullish strategies[ edit ] Bullish options strategies are employed when the options trader expects the underlying stock price to move upwards. The trader may also forecast how high the stock price may go and the time frame in which the rally may occur in order to select the optimum trading strategy for buying a bullish option. The most bullish of options trading strategies, used by most options traders, is simply buying a call option.
Since implied volatility is statistically overpriced, the underlying security is likely to stay within the range defined by the options prices. Taking profits early further improves the probability of success.
Source: TastyWorks Strategy 2 Moderately Aggressive A slightly less risky neutral options strategy for a high implied volatility market is the short strangle.
Like the straddle, the short strangle makes money from the passage of neutral options strategies and a decrease in volatility.
3 Best Direction Neutral Options Trading Strategies
The higher the credit collected, the farther out the break-even points. Unlike the straddle which sells ATM options, the strangle gives a trader more flexibility for determining their probability of profit by choosing strike prices.
Typically in a higher volatility market, you should sell the delta options. If the price moves outside that range, you can roll up or down either strike to collect an additional credit to offset any loss. Source: TastyWorks Strategy 3 Less Aggressive The last neutral options strategy for a volatile market is the short iron condor.
neutral options strategies
Neutral Market Trading Strategies
The iron condor is the least aggressive of all 3 strategies because neutral options strategies has defined risk. The trade-off of a defined risk trade is that it has a lower probability of profit. But iron condors are great for smaller accounts or for stocks with a high price. Like the straddle and strangle, the short iron condor benefits from the passage of time and a decrease in implied volatility.
The optimal time to sell an iron condor is when the IV rank of the underlying neutral options strategies is high.
While this is technically accurate, in the context of options trading the word has a slightly broader meaning.
Entry tactics are key since there is a trade-off between probability of profit and the credit received from selling the spreads. A spread is just a defined risk trade that buys and sells either call or put options at different strike prices in the same expiration. Source: TastyWorks Conclusion Becoming a consistently profitable options trader means knowing when to exploit your edge.
When selling options, the mathematical edge is in overpriced implied volatility. Stick to the probabilities and the profits take care of themselves.