Larry’s Note: Ever since hostilities broke out in Iran, volatility has been going through the roof.
Even before the war, the market was already dealing with another major change – the unwinding of the artificial intelligence (AI) trade. Given AI stocks’ huge weightings in the indexes, this has been no ordinary event. It’s shaking the underpinnings of the market.
So when we throw in all the geopolitical events on top of that, you can bet that we’re primed to see lots of swings ahead – which could prove highly lucrative if you know how to trade it.
That’s why I’m hoping you’ll attend my AI Chaos to Cash event tomorrow at 2 p.m. ET. I’ll show you one of my favorite strategies for pulling hundreds and thousands of dollars out of the market nearly every week.
You can RSVP here with one click. And if you sign up as a VIP, you’ll also receive my AI forecast for the year ahead with two specific recommendations: one potential buying opportunity and another one to avoid.
So please join me tomorrow, and I’ll show you how to put all this volatility to work.
When folks buy an option, they think that they’re profiting from a move in the underlying stock. If bullish on a stock, they’ll buy a call option, which benefits if the stock goes up. If bearish, they’ll buy a put option, which gains value when the stock drops.
But whether they know it or not, they’re also making a play on volatility…
Volatility is how the stock market prices uncertainty. The higher the uncertainty, the more expensive the options are… and vice versa. Every option you buy or sell comes with expectations about the size of future price moves.
This dynamic can catch new option traders off guard… because sometimes it means the difference between a winning trade and a loss.
So today, let’s look at how to factor volatility into your trading system…
It’s incredibly frustrating to get a trade’s direction right but still lose money. This is where volatility fits into the picture.
Volatility can spike based on an earnings report, jobs report, inflation number, or Federal Reserve meeting, as just a few examples. Option premiums become more expensive leading up to major events and announcements because unexpected information could shake the market.
But often, nothing surprising comes out…
Say the numbers come in right around expectations. What could have been a shock fizzles into nothing.
That’s where a trap can hide for inexperienced traders. If you bought an option in the lead-up to one of these big moments, you might see the value of your option collapse when volatility rapidly contracts.
Instead, the key is to let volatility help determine your strategy…
If volatility is high and options are expensive, you may want to avoid buying an option. Even if you get the direction right, falling volatility (even if it just reverts to its mean) can turn the trade into a loser.
Instead, when buying an option, you want to buy when volatility is low… but you’re expecting it to rise. Getting the direction right and capturing rising volatility can help propel your trade into the winner’s circle.
On the flip side, you want to avoid selling options if volatility is low. One left-field event can spook the markets, sending option premiums soaring. That can turn your trade into a significant loss.
Only consider selling or placing short option trades (including spread trades) when volatility is reasonably high. If volatility falls (or reverts) a bit, it can put your trade into profit.
In short, you should pay attention when volatility (and option premiums) are out of whack and trading at excessive prices. You want to sell that excess volatility and buy the option back at a lower price.
Once you’ve mastered these dynamics, you’ll be several steps ahead of the crowd… and you’ll be able to start harvesting volatility with your trading strategy.
Happy Trading,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
