Advanced options trading strategies can allow you to benefit from future volatility levels, by effectively buying and selling volatility.
If you think a market is likely to be volatile in the weeks ahead or on any given day, you can take a position and trade on the volatility itself, even if you’re not sure of the direction you expect it to move. ‘Volatility trades’ can be placed using binaries and/or options. Read more on Binary Trading.
If you expect volatility in a market, you can buy both a put and a call. This approach would let you benefit from any large move in the underlying market, whether up or down.
'Volatility trading' with options
We offer a wide range of options on forex pairs, global indices, commodities, interest rates and more. Below are a couple of examples of using options to trade volatility:
- 'Buying volatility' on the Australia 200
- 'Selling volatility' on AUD/USD
'Buying volatility' on the Australia 200
The Australia 200 is currently up 5 points on the day, trading at 4600, and you are aware that the Australian GDP is due at 11:30. You think that the index will move considerably following the GDP announcement, but you think it could move either up or down. In this example, your risk is strictly limited.
To take a position on the volatility you expect, you trade ‘Daily Australia 200 options’, buying:
A$10 of the 4600 Call at 12, and
A$10 of the 4600 Put at 14
Such a trade would be called a ‘Daily 4600 Australia 200 Straddle’.
As you’ve paid a total of 26 (12+14) to break even, you will need the Australia 200 to move 26 points up or down from 4600 (4574 or 4626) to return a profit. For every point the index moves beyond these levels, you’ll make A$10.
Should the Australia 200 move higher to finish at 4670, for example, you would make 44 points overall:
4670 (final Australia 200 level) – 4600 (opening level) – 26 (the total premium you’ve paid to buy the call and put option) = 44.
As you’ve bought A$10 per point, your total profit would be A$440 (44 x 10).
The worst-case scenario in this instance would be for the Australia 200 not to be affected by the Australian GDP, and to finish at 4600. In such an event, you would lose A$260 (A$26 premium x 10 stake). In this respect, A$260 is your total risk on this position.
'Selling volatility' on the AUD/USD
Another options strategy is ‘selling volatility’, allowing you to take the position that a market will not have a significant move over a set time period, be it one day or several weeks, for example.
If you think a big move on – for example - AUD/USD unlikely, you can back your judgment by selling daily AUD/USD, by either individually selling a put or call or as a straddle (selling a put and a call). For example, the price of a A$/$9200 straddle when AUD/USD is 9202 is priced at 35-39 for the call and 33-37 for the put.
You may take the view that it’s highly unlikely that AUD/USD will move more than 68 points before the expiry, and so choose to sell both the daily AUD/USD 9200 call and the 9200 put:
A$10 of the 9200 call at 35, and
A$10 of the 9200 put at 33
In doing so, you have sold a ‘daily 9200 AUD/USD straddle.’
As you have sold at a total of 68 (35 + 33), the AUD/USD will need to finish within 68 points of 9200 to return a profit. Every point outside this range - under 9132 (9200 – 68) or over 9268 (9200 + 68) - will lose you A$10.
The best-case scenario, in this example, would be no movement in the AUD/USD, closing at 9200. If this were to happen, both options would finish worthless and you would make A$10 x 68 = A$680.
It is important to remember that when selling options, although your profit is limited, your risk is not.