What are your options: Fall 2024: Strategic guidelines for volatile markets

Premium selling strategies: benefit from high volatility

When volatility increases, so do the premiums on options. As a result, premium-selling strategies become particularly attractive. Selling options allows you to capture this increased premium, as time decay works in your favor, and you profit if the underlying asset doesn’t move significantly in either direction.

What to focus on:

• Covered calls: If you hold stocks that you don’t mind parting with at a higher price, covered calls are a great way to generate income from the elevated option premiums.
• Iron condors and credit spreads: These strategies let you capitalize on the high premiums while limiting your risk. Since volatility is high, expanding the strike prices in your spreads can give you more room for the inevitable market swings.
• Risk reversals: In volatile markets, risk reversals can allow traders to position themselves for directional moves while generating premium. A typical risk reversal involves selling a put and buying a call (or vice versa), effectively betting on directional movement while offsetting the cost of the long option with the premium received from the short option.

Why it works:

• High volatility means option prices are elevated, allowing you to sell premium at more favorable rates.
• Time decay (theta) works in your favor as an option seller, particularly when the market consolidates or moves less than expected.
• Risk reversals allow you to position for directional moves at a lower cost by using the premium collected from selling the put (or call) to offset the cost of the call (or put), especially in high-volatility scenarios.

How to execute:

• Widen your strikes: Give yourself more room for the market to fluctuate. With heightened volatility, spreads with wider strike prices allow more flexibility.
• Shorter expirations: Higher volatility tends to compress time decay, so selling options with shorter expirations can help capture premium while limiting your exposure to prolonged market uncertainty.
• Construct risk reversals strategically: If you're bullish on an underlying, consider selling an out-of-the-money put and buying an out-of-the-money call to capture directional moves without paying full premium for the call. Conversely, use the reverse structure in bearish scenarios.

Risks to consider:

• Volatility spikes: While selling options benefits from high volatility, further spikes in volatility can increase your risk, especially if you're short naked options. This can lead to significant losses.
• Sudden market moves: Selling options can leave you exposed if the market moves sharply in one direction. Widening your strikes reduces some risk, but rapid price changes can still result in losses.
• Unlimited risk on naked options: Selling naked calls or puts exposes you to potentially unlimited losses. If the underlying asset moves significantly, you may face substantial losses. Spreads and structured strategies like risk reversals can help mitigate this risk.

Premium buying strategies: capitalize on big moves—with care

While selling premium can seem like the more obvious play in a high-volatility market, buying options remains a viable strategy—especially if you're expecting a strong directional move. However, with options trading at higher prices due to increased implied volatility (IV), you need to be more selective and strategic to make option buying work in your favor.

What to focus on:

• Longer-dated options: Buying options with longer expiration dates helps mitigate the effects of time decay and gives your position more time to reach its profit target.
• Directional plays on strong catalysts: Be selective about the underlyings you choose. Focus on assets where you expect clear and strong directional moves, such as stocks with upcoming earnings, major market events, or those showing strong technical signals.

Why it works:

• In a volatile market, big directional moves can still happen. If you anticipate these moves and time your entry well, option buying can yield substantial returns.
• Buying longer-dated options reduces your exposure to theta-decay, allowing you to hold positions longer without losing significant value due to the passage of time.

How to execute:

• Look for lower IV on entry: High IV means expensive options, so try to enter your long positions when implied volatility is slightly lower—after a brief pullback or consolidation.
• Spread strategies to offset costs: Consider debit spreads or diagonal spreads to reduce the upfront cost of buying options. Spreads help balance the impact of time decay and can make your long positions more affordable while still offering upside potential.

Risks to consider:

• Time decay (theta): As a buyer, time decay works against you. If the underlying asset doesn’t move quickly enough, you could lose money simply due to the passage of time. Longer-dated options can help mitigate this risk but won’t eliminate it entirely.
• Volatility drop (vega): If implied volatility falls after you enter the trade, the value of your option could decrease, even if the underlying asset moves in your favor. This is particularly important when buying options in a high-volatility environment.
• Directional risk: Buying options requires the underlying asset to move significantly in your favor for the trade to be profitable. If the expected move doesn’t occur, the option could expire worthless, resulting in a full loss of the premium paid.

Adapting to theta and vega in a volatile market

Whether you are buying or selling options, it’s crucial to understand how market volatility affects the Greeks, particularly theta (time decay) and vega (volatility sensitivity).

• Theta: As an option buyer, time decay will erode your position’s value if the underlying asset doesn’t move fast enough. This makes it critical to time your entry and consider longer-dated options. For sellers, theta is your friend—time decay works in your favor, especially with near-term options.

• Vega: Rising volatility increases the value of options, benefiting buyers if IV rises after you’ve entered the trade. However, sellers need to account for the risk of further volatility increases, which can inflate option values.

How to navigate:

• Monitor vega: Option buyers can benefit if volatility spikes after entering, but sellers need to be cautious about volatility increases.
• Mind theta: Buyers should focus on longer-term options to minimize the impact of time decay, while sellers can take advantage of near-term opportunities.

Balance your portfolio with market-neutral strategies

Given the unpredictable market conditions, where a strong directional bias could lead to unwanted losses, incorporating market-neutral strategies can help you profit from volatility without taking on excessive risk.

Strategies to consider:

• Buying straddles and strangles: If you expect large moves but aren’t certain of the direction, buying straddles or strangles can allow you to profit from volatility regardless of which way the price moves. A straddle involves buying both a call and a put at the same strike price, while a strangle involves buying a call and a put with different strike prices. These strategies are more suitable when you expect significant volatility and price movement.
• Selling straddles and strangles: If you expect the market to stay within a specific range or for volatility to decrease, selling straddles and strangles can be more suited to a market-neutral approach. Here, you profit from the premiums collected as long as the underlying asset doesn’t make large moves in either direction. This is especially attractive when implied volatility is high, and you don’t expect extreme price movement.
• Iron butterflies: These can help capture premium in a market that you expect to stay within a certain range, while also limiting risk on both sides. This strategy benefits from the elevated premiums in the options market and works well when you expect minimal movement.

Risks to consider:

• Directional moves: Even with market-neutral strategies, significant directional moves can result in losses. Buying straddles and strangles require large price swings to be profitable, and if the market consolidates instead, you may lose money due to time decay. Selling straddles and strangles, on the other hand, exposes you to potentially unlimited losses if the underlying moves dramatically in either direction.
• Increased costs: Market-neutral strategies often involve buying or selling multiple options, which can increase transaction costs. These costs can eat into your potential profits, especially if the market doesn’t move as expected.

Be selective with underlyings

This is true for both premium sellers and premium buyers. Given the elevated implied volatility across many sectors, it’s essential to be selective about the assets you trade. Not every stock or commodity will move dramatically, and volatility across sectors can vary.

How to execute:

• Focus on strong catalysts: Whether it’s earnings, geopolitical events, or major economic reports, choose underlyings where you expect clear and impactful price movement.
• Diversify across asset classes: With volatility affecting more than just stocks, consider options on commodities, bonds, or sectors that have their own volatility profiles (such as energy or tech).

Risks to consider:

• Misjudging catalysts: Even if an asset has strong catalysts, market sentiment can shift unexpectedly, and the anticipated move may not happen. This can result in losses, particularly for buyers who rely on a significant directional move.
• Sector-specific volatility: Some sectors may experience higher volatility than others, which could lead to over- or underestimation of market risk. It’s important to tailor your strategy to the asset’s volatility profile.

Conclusion: a balanced approach to volatility

Fall 2024 presents a complex but opportunistic market environment. With volatility rising, both premium-selling and premium-buying strategies offer paths to success—but only if carefully adapted to current conditions. Selling options allows traders to capitalize on elevated premiums and time decay, but option buying remains a viable approach when paired with selective timing, longer time frames, and proper risk management.

By combining thoughtful timing, selective underlying choices, and the appropriate mix of buying and selling strategies—while keeping a close eye on the risks—traders and investors alike can navigate the volatility ahead and position themselves for potential gains, regardless of the market's direction.