Good Times for Trading Options

T.D. Thompson — Wed, 26 May 2010 14:12:17 +0000

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Bad times for investing in stocks are often good times for trading options. Such are the times today. Volatility is the order of the day. One is reminded of Alvin Toffler’s book, “Future Shock,” in which he, correctly, predicted 40 years ago that society would not only change going forward but that the rate of change would progressively increase. So it seems with current market volatility. For someone with a nest egg looking forward to a comfortable, safe, and secure retirement the market today stinks. For the options trader with sufficient capital today’s volatile market provides virtually unlimited opportunity. Today would seem to be a much better time for a long straddle on many stocks than for a short straddle on almost anything in sight.

The uncertainty that produces volatility is infectious to the point where many strong companies with good balance sheets and lots of cash get pulled into a cycle of fear. Companies selling things like basic laundry soap, basic phone service, and replacement spark plugs will not likely ever go out of business although such companies, according to fundamentals, will never see their shares multiply a hundred fold. Nevertheless these companies often suffer as the market fear factor sinks all ships. Just like the value investor looks for intrinsic value in stocks the options trader can look past the fear factor for strong fundamentals, watch for technical indications of price movement, and buy options where there is promise of profit. Using a long straddle the trader is betting on price movement and is not sure if it will be up or down. He or she is betting on extreme price volatility. Using a short straddle strategy the trader believes that price volatility, at least for the stock in question, will cease, entirely. If he or she is wrong the results can be devastating. This is why much of the business of selling options resides in the halls of large institutional investors with very deep pockets. Looking at the two kinds of options trading, buying versus selling, buying seems a safer and potentially more lucrative proposition during these good times for trading options.

Good times for trading options can also be expensive times for options. Because of the risk inherent in a volatile market the sellers of puts and calls will be asking for higher premiums. The view of the buyer will be that the price is high. The view of the seller, who is assuming all risk, is that the price could be far too low. Thus the trader need be mindful of the degree of opportunity a option offers and just how much the underlying need change in price for the purchase to be profitable. Risk management in options trading entails a clear view of know cost versus potential profit. However, periodic performance review is essential because potential profits are not profits. The wise trader keeps track of what he or she traded and exactly why he or she picked the underlying to trade at a given premium and given market conditions. This way a trader can trade successfully during bad times as well as good times for trading options. This is how traders develop successful strategies and is a step towards making a living trading options.

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Good Times for Trading Options

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