The post below is from Eric at The Stock Market Prognosticator. Free free to leave a comment or let him know if you have any other option tips you would like him to write about.
It is important for investors not panic during the current market volatility. Money can be made on both the upside and downside. One of the strategies I employed recently involves using options to take advantage of this volatility. During the month of July, I opened "straddle" positions on six different stocks and ETF's. I closed all of them out at a profit within two weeks.
So here is how it works, a straddle is the simultaneous purchase of an equal number of both calls and puts on the same underling stock, ETF, or index. Both the calls and the puts should have the same strike price and same expiration.
What I am looking for is a large move by the stock before the options expires. I am indifferent as to which way the market moves, as long as the combined premium when I close it out is more than the combined premium that I paid.
Here are some other things to know:
1) Make sure that the options have several weeks to expiration so there is time for the underlying instrument to move.
2) Pick only options with large volume and narrow spreads, a few pennies per contract is best.
3) Be careful about using this strategy when the underlying instrument has very high-implied volatility, as all other things being equal, a high implied volatility leads to a higher option premium. If this implied volatility suddenly dissipates then one side of your position may drop sharply in price.
4) I usually wait until the underlying instrument is trading right at the strike price, so the options cast per contract is roughly the same.
Here is an example of one of my trades:
I purchased the Financial Select Sector SPDR (XLF) July 21 Calls and July 21 Puts at a price per contract of $1.14 and $1.13 respectively. This position was opened prior to the huge rally in financials last week. Four days later I closed the position out, selling the calls at $2.28 and the puts at $0.51 per contract. The profit before commissions per contract was $0.53, or $53.00. So a round lot of 100 contracts would have yielded a profit of $5,273 in less than a week.
Investing in options carries a lot of risk, so please decide yourself whether a strategy like this is correct for you as an investor.
If you would like to learn more about my investment philosophy, then please visit The Stock Market Prognosticator.