Buying and selling volatility is an advanced options strategy that can allow you to take advantage of future volatility levels.
If you have a view that a market is going to be volatile over the next few weeks or on a particular day, you can take advantage by trading on the volatility itself, even if you’re not sure which direction the market will move. At IG Markets 'volatility trades’ can be placed using binaries and/or options. Find out more about binary trading.
If you believe a market will be volatile, you could buy both a put and a call option. It’ll allow you to benefit from any large move in the underlying market, whether it's a move down or up.
It is important to note that options can never be exercised with IG Markets. You’re only trading on their value.
'Volatility trading' with options
We offer a wide range of options on global indices, forex pairs, individual shares, commodities, interest rates and more. Take a look at some examples of how you use volatility as an options strategy:
'Buying volatility' on the Australia 200
The Australia 200 is currently up 5 points on the day, trading at 4600. You know the Australian GDP is due out at 11:30. You believe the Australia 200 will have a big move once the numbers are announced, but you’re not sure if it will move down or up. In this example, your risk is strictly limited.
To take advantage of the expected volatility, you decide to trade ‘Daily Australia 200 options’ and you buy:
A$10 of the 4600 Call at 12, and
A$10 of the 4600 Put at 14
This trade is called a ‘Daily 4600 Australia 200 Straddle’.
As you’ve paid a total of 26 (12+14), to break even, you’ll need the Australia 200 to move 26 points away from 4600 in either direction (4574 and 4626). For every point the Australia 200 moves further from these levels, you’ll make A$10 per point.
So if the Australia 200 moves higher and finishes at 4670, you 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 is A$440 (44 x 10).
Your worst-case scenario in this example would be if the Australia 200 was not impacted by the Australian GDP, and finished at 4600. You would lose A$260 [A$26 (premium) x 10 (stake)]. This A$260 represents your total risk on this position.
'Selling volatility' on the AUD/USD
Options can be used to ‘sell volatility’. They allow you to profit from your belief that the Australia 200 (or any other given market) will NOT have a significant move on a particular day or over the next few weeks.
If you think it is unlikely that there will be a big move on AUD/USD, you can back your judgment by selling daily AUD/USD. It can be done by either individually selling a put or call or as a straddle (selling a put and a call). For example, the price of a A$/$ 9200 straddle when AUD/USD is 9202 is priced at 35-39 for the call and 33-37 for the put.
You have a view that it’s very unlikely that A$/$ 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$10 of the 9200 put at 33
You have sold a ‘daily 9200 AUD/USD straddle’
As you have sold at a total of 68 (35 + 33), you’ll need the A$/$ to finish within 68 points of 9200 to make a profit. For every point outside this range, ie. under 9132 (9200 – 68) or over 9268 (9200 + 68), you will lose A$10/point.
The best-case scenario, in this example, is if the AUD/USD doesn’t move and closes at 9200. If this was to occur, both options finish worthless and you make A$10 x 68 = A$680.
It is important to understand that when selling options, your risk is unlimited.