The Advantages of Options in a Volatile Market
The broader equity markets have seen a period of intense volatility. Yesterday’s trading session capped off a 5 day losing streak for the Dow, the longest in over a year.
I made the most money in my trading career during times like this and did with the options market. I focused on options during volatile times because they have some distinct advantages over stock when it comes to risk management and reward potential.
Below I will go over some of these advantages and why you may want to consider trading more options during times of increased volatility.
Risk Less to Get Leverage
Options let you leverage stocks to realize much bigger gains on even small price changes in the underlying stock. This allows you to risk less capital with a large potential for profit.
Options also protect you from gap risk and other outsized or unexpected moves. They can do this because they have “built in” stops.
How does this work?
Simple; say you buy 1 XYZ Call Option for $100.00
Your maximum risk is $100 in this position and you have a built in stop because the position can never be worth less than 0. If tomorrow the stock falls 50% you will still only lose $100 in the position.
Holding a position in the underlying stock would actually expose you to way more risk in this situation than the options do. This is a huge advantage in markets that are volatile and hard to predict.
This makes for a powerful trading tool that you should have in your arsenal.
Using Put Options To Short Stock
A “put” is an equity options contract that gives you the right but not the obligation to sell a security for a certain price at a certain time.
Example: You buy the XYZ Feb 100 Strike put for $1.00 (this costs a total of $1,000)
This gives you the right to sell 100 shares of XYZ for $100 on February expiration. To own that right, you need to pay for the option today.
Let’s say the stock is at $90 on expiration. Since you have the right to sell for $100, you will collect the $10,000 difference. You paid $1,000 for the option when you put the trade on, so your net profit is $9,000.
This is a much better reward-to-risk setup than the outright short stock. Unlike the short stock position, you only needed to invest the $1,000 it took to buy the put option.This type of return potential is one of the benefits of leverage.
When the market is moving lower more often than it is moving higher this might be your only opportunity to trade for profit.
Getting Started With Options
If you haven’t traded bearish positions using puts before, you should consider it. There are many risk management benefits to trading options.
Start out with a sim account (“simulated” account) and get used to trading puts instead of shorting stock. Learn to embrace the leverage that options provide, and soon you’ll be an options master.
AKA, “The Alpha Shark”