Volatility and Options Trading Stock market volatility is arguably one of the most misunderstood concepts in investing. Simply put, volatility is the range of price change security experiences over a given period of time.
If the price stays relatively stable, the security has low volatility.
A highly volatile security hits new highs and lows quickly, moves binary option on weekends, and speculation in options forts rapid increases and dramatic falls. Because people tend to experience the pain of loss more acutely than the joy of gain, a volatile stock that moves up as often as it does down may still seem like an unnecessarily risky proposition.
However, what seasoned traders know that the secret to make money person may not is that market volatility actually provides numerous money-making opportunities for the patient investor.
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Investing is inherently about riskbut risk works both ways. Each trade carries with it the risk both of failure and of success. Without volatility, there is a lower risk of either.
Key Takeaways Volatility can be turned into a good thing for investors hoping to make money in choppy markets, allowing short-term profits from swing trading. Day traders focus on volatility that occurs speculation in options forts or minute-to-minute, while swing traders focus on slightly longer time frames, usually days or weeks, Traders looking to capitalize on volatility for profit may use such indicators as strength indexes, volume, and established support and resistance levels.
Warren Buffett's view on using futures and options contracts rather than buying the stock
Traders can also trade on the VIX or use options contracts to capitalize on volatile markets. Volatility and Market Fluctuation Volatility can benefit investors of any stripe.
Many more conservative traders favor a long-term strategy called buy-and-holdwherein a stock is purchased and then held for an extended period, often many years, to reap the rewards of the company's incremental growth.
This strategy is based on the assumption that while there may be fluctuations in the market, it generally produces returns in the long-run. While a highly volatile stock may be a more anxiety-producing choice for this kind of strategy, a small amount of volatility can actually mean greater profits. As the price fluctuates, it provides the opportunity for investors to buy stock in a solid company when the price is very low, and then wait for cumulative growth down the road.
Swing and Short-Term Traders For short-term traders, volatility is even more crucial. Day traders work with changes that occur second-to-second, minute-to-minute. If there is no price change, there is no profit.
Swing traders work with a slightly longer time frame, usually days or weeks, but market volatility is still the cornerstone of their strategy.
As price seesaws back and forth, short-term traders can use chart patterns and other technical indicators to help time the highs and lows.
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Using indicators such as Bollinger Bandsa relative strength indexvolume, and established support and resistance levels, swing traders can pick out potential reversal points as price oscillates. This means they can go long on the stock, or buy calls, as price nears a low and then ride the upswing to sell at or near the high. Similarly, predicting when a volatile speculation in options forts is exhausting its current bullish momentum can mean shorting the stock, or selling putsjust as the downturn begins.
These types of short-term trades may produce smaller profits individually, but a highly volatile stock can provide almost infinite opportunities to trade the swing.
Numerous lesser payoffs in a short period of time may well end up being more lucrative than one large cash-out after several years of waiting.
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As a result, these instruments are best utilized in longer term strategies as a hedging tool, or in combination with protective options plays. Puts are options that give the holder the right to sell the underlying asset at a pre-determined price.
If an investor is buying a put option to speculate on a move lower in the underlying asset, the investor is bearish and wants prices to fall. When establishing a protective put, the investor wants prices to move higher, but is buying puts as a form of insurance should stocks fall instead.
If the market falls, the puts increase in value and offset losses from the portfolio. While puts gain value in a down market, all options, generally speaking, gain value when volatility increases. A long straddle combines both a call and a put option on the same underlying at the same strike price.
The profit profile is the same no matter which way the asset moves. In addition to straddles and puts, there are several other options-based strategies that can profit from increases in volatility. Long straddle. These include white papers, government data, original reporting, and interviews with industry experts.
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