In the video “Option Trading For Beginners – How To Use Volatility Spikes To Get Quick Profits” by Options with Davis, you’ll learn about the best time to enter a trade when selling options: when volatility is high. The video focuses on a trade that took advantage of a volatility spike in the iShares Russell 2000 ETF (IWM), resulting in quick profits. You’ll also discover how to identify opportunities in the market, the importance of diversifying strategies and price levels, and the benefits of vertical diversification with a watch list of about 10 stocks or index ETFs. By understanding these concepts, you can enhance your options trading skills and improve your long-term results.
In this engaging and informative video, Options with Davis explores the topic of profiting from overreactions and volatility spikes in the market. By taking advantage of high volatility and selling premium during these spikes, you have the opportunity to collect juicy premiums and achieve quick profits. The video delves into a real trade example using the iShares Russell 2000 ETF (IWM), highlighting the positive aspects of delta, theta, and vega when selling a short put option. Additionally, the video discusses diversification strategies, the income grid method, and different bullish, bearish, and neutral strategies based on market sentiment. By applying these strategies and understanding the probability game of options trading, you can increase your chances of success and create a more balanced options portfolio.
Option Trading For Beginners – How To Use Volatility Spikes To Get Quick Profits
The Best Time to Sell Options
When it comes to selling options, the best time to get into a trade is when volatility is high. This is because high volatility allows traders to collect more premium, which can lead to juicier profits. Volatility spikes present opportunities for selling premium, as they often result in increased option prices. As premium sellers, we want to take advantage of these spikes whenever there’s an opportunity. By identifying and capitalizing on these high-volatility periods, traders can increase their chances of earning quick profits.
Opportunities Presented by Volatility Spikes
Volatility spikes, such as those caused by market sell-offs or major news events, can present excellent opportunities for option traders. During these periods, the volatility index (VIX) tends to rise, leading to higher option prices and increased option premiums. When volatility is high, option sellers can command larger premiums for their options, leading to potentially higher profits.
Case Study: iShares Russell 2000 ETF (IWM)
To illustrate the potential of profiting from volatility spikes, let’s take a look at a recent trade involving the iShares Russell 2000 ETF (IWM). During a market sell-off, IWM experienced a significant drop in price, accompanied by a surge in volatility. This presented a prime opportunity for option sellers to take advantage of the spike in premium.
Selling a Short Put Option During a Market Sell-Off
During the market sell-off, when IWM was trading at around $171, a short put option was sold with a strike price of $164. This option had positive delta, positive theta, and negative vega, making it an attractive trade. The short put option was sold for a premium of $4.51, with around 45 days left until expiration.
Characteristics of the Short Put Option
The short put option has three factors working in its favor. First, it has positive delta, which means that as the market goes up, the option will be in profit. Second, it has positive theta, which means that over time, the value of the option will start to decay. Lastly, it has negative vega, which means that it will profit from a decrease in volatility. These characteristics make the short put option an effective strategy for capitalizing on market movement, time decay, and volatility drop.
Profiting from Market Movement, Time Decay, and Volatility Drop
As the market rebounded and the volatility dropped, the short put option quickly turned into a profitable trade. In just a matter of days, the option was showing nearly 50% profit, with the premium reaching around $2.44. This demonstrates the potential for quick profits when selling options during periods of high volatility.
Current Profitable Position of the Stock
After the market rebounded, IWM closed at around $171, the same level at which the short put option was initially sold. Despite the price remaining relatively stable, the option remained in profit due to the drop in volatility. This highlights the importance of understanding and capitalizing on volatility spikes, regardless of the stock’s price movement.
Looking for Opportunities to Profit from Market Overreactions
Market overreactions, such as the recent fiasco with banks in America, can create ideal trading opportunities. During these periods, stock prices often experience large swings and volatility spikes. By carefully monitoring market events and identifying overreactions, traders can position themselves to profit from these price movements.
Utilizing Technical Indicators and Support/Resistance Levels
For traders who have knowledge of technical analysis, support and resistance levels can be valuable tools for identifying entry and exit points. By studying chart patterns, trendlines, and other technical indicators, traders can gain insights into potential market movements. This can help them determine where to place their trades and maximize their profit potential.
The Income Grid Method for Identifying Trading Opportunities
The income grid method is a popular approach used by option traders to identify trading opportunities. It involves drawing different price levels on a chart and analyzing potential strategies for each level. By visualizing different scenarios and considering bullish, bearish, and neutral strategies, traders can make informed decisions and execute their trades accordingly.
Horizontal Diversification in Option Trading
One approach to diversification in option trading is horizontal diversification. This involves entering trades into different stocks within the same sector. While horizontal diversification can spread risk across multiple stocks, it is important to note that all positions may be affected if the entire sector crashes. Therefore, caution should be exercised when employing this strategy.
Vertical Diversification in Option Trading
Vertical diversification is a preferred approach for many option traders. It involves sticking to a single stock or index ETF and entering different strategies at different price levels. By diversifying vertically, traders can capitalize on specific opportunities presented by individual stocks or ETFs while minimizing overall risk.
Diversification Across Different Sectors
Diversifying across different sectors is generally considered more desirable than diversifying within the same sector. This is because each sector tends to have its own unique characteristics and performance patterns. By spreading investments across various sectors, traders can mitigate the impact of sector-specific events and reduce the overall risk of their options portfolio.
Preferred Approach: Vertical Diversification with a Watchlist
A preferred approach to diversification in option trading is vertical diversification with a watchlist. This involves maintaining a watchlist of around 10 stocks or index ETFs and entering different strategies at different price levels. By focusing on a select group of securities, traders can closely monitor market developments and act quickly when opportunities arise.
The Income Grid and its Four Choices for Each Price Level
The income grid method offers four choices for each price level: bullish strategy, bearish strategy, neutral strategy, or no trade. This allows traders to evaluate different scenarios and select the most suitable strategy for each price level. By considering multiple options and refining their decisions, traders can potentially increase their long-term profitability.
Placing Trades with a Clear Opportunity or View
When placing trades in option trading, it is advisable to only do so if there is a clear opportunity or view on the underlying stock. This helps to ensure that trades are based on well-founded reasoning and not simply speculative in nature. By making informed decisions, traders can increase their chances of success and minimize the risks associated with blind trading.
Market Extended to a Price Level of 195
As the market extended to a price level of 195, different strategies can be implemented based on market sentiment. Depending on whether the sentiment is bearish, neutral, or bullish, traders can adjust their strategies to align with their view on the market. This flexibility allows traders to adapt to changing market conditions and maximize their profit potential.
Implementing Different Strategies Based on Market Sentiment
When implementing different strategies based on market sentiment, bearish strategies such as bear call spreads can be employed during periods of expected price decline. Neutral strategies, on the other hand, are suitable for sideways movement in the market. Finally, bullish strategies can be implemented when there is a potential for a price increase or a step back in price.
Diversifying Strategies, Price Levels, and Expiration Dates
To create a more balanced options portfolio, it is beneficial to diversify across different strategies, price levels, and expiration dates. This diversification helps to spread the risk and minimize potential losses. By employing a mix of bullish, bearish, and neutral strategies with varying expirations, traders can position themselves for long-term success.
Benefits of Diversification in Options Trading
Diversification is a key component of successful options trading. By spreading investments across multiple stocks, sectors, and strategies, traders can reduce their exposure to specific risks and increase their chances of profiting from a variety of market conditions. Diversification helps to smooth out profit and loss experiences, leading to more consistent and stable results over the long term.
Options Trading as a Probability Game
Options trading is often referred to as a probability game. This is because options prices are influenced by the implied volatility, which is often higher than the actual volatility experienced in the market. As premium sellers, option traders can take advantage of this disparity by selling options with higher implied volatility, increasing their chances of profitable outcomes.
Long-Term Positive Results with Diversification
By diversifying their trading approach and employing a combination of strategies, price levels, and expiration dates, traders can position themselves for long-term positive results. While individual trades may be subject to market fluctuations, a diversified portfolio ensures that losses in one area can be offset by gains in another. This leads to a more consistent and stable profit potential over time.