Ways to Profit from Option Volatility

You can use an option volatility and make it work for you. Many psychological studies have found that humans have an optimistic bias. You can use this information and capitalize on it. Options allow you to move on the short term movements of a stock. You might believe that the general trend of the company will be positive, but there is nothing wrong with buying a few put options to capitalize on short term declines. Here are a few other ideas to help you maximize your profit:

Pick Reactive Stocks

There are a few sectors and stocks that are particularly vulnerable to surprise announcements or events. This is particular true in newer industries. Examples of such stocks  are those in the technology sector, overvalued stocks, stocks with a single drug under FDA review underlying it, and stocks in volatile industries. The higher the perceived risk in the stock, the higher premiums the stocks will demand. This means higher profits for you.

Expiration Plays

Expiration plays are plays that are made in the last week before expiration of an option. If an option is very close-to-the-money, options you trade during this week can change in value very quickly. You might find that the best expiration plays are those on index options.

An example of index options is those in the S&P 100 Index. In order to make money from this strategy, you buy on weaknesses in the option price. You are betting that surprise volatility will swing the price of the option in your favor. In times of  high overall volatility in the market, this strategy is especially useful. You might incur many losses with this strategy, but you might also get a huge jackpot. Be warned: this strategy is not for the weak of heart.

Give Yourself Enough Time

Make sure you do not stack the odds against yourself. You should give yourself enough time to be right. Options are not perpetual instruments like stocks. They are an asset with an expiration date. The price of options goes down the closer to the expiration date it gets. Buyers often buy options too close to the expiration date. Make sure to buy at least 30 days or more before expiration so that you have ample amount of time to profit.

Covered Calls

Selling covered calls and puts on your stocks can help you hedge your equity portfolio. If you believe a stock in your portfolio will rise, you can sell a covered call. If you believe a stock in your portfolio is going to fall, you can sell a covered put.

For example: let’s assume you sold options that have a strike price that is higher than the price that you paid for the stock. If the stock declines in value or remains flat, you get to keep the premium you received when you sold the option. Thus you are hedging against losses to your portfolio. If the stock gains value and gets called away, you may still make a profit, and perhaps a higher one than you would have made if you had just owned the stock.

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