Using Options Trading in a Motionless Market

Using Options Trading in a Motionless Market

Options trading has often been seen by traders as a confusing concept that can lead to losses rather than leading to profit. This is true of all financial instruments, if not researched thoroughly. However, options trading can be used during times of low market volatility and movement, which has been the case for the majority of 2012 thus far, and trade on this low volatility itself, in order to produce a profit.

The Fundamentals

It is important to first understand how options work. An option gives you the right (but not the obligation) to trade an asset at a set market price before a set time. A ‘put’ option gives you the right to sell an asset at a set price, while a ‘call’ option allows you to buy. Should the market move in your favour, these options become valuable as they would allow you to either buy below the current underlying value or sell above it.

Selling Volatility through a Straddle

With CFD trading, you are able to ‘sell’ as well as ‘buy’ an option. Selling put and call options is what allows you to potentially profit from a sleeping market. The best way to explain this options trading method is through an example.

If we take the Australia 200 (ASX 200) stock index, you may believe that the current underlying market is not moving much and so want to use options trading to profit from this lack of volatility. In this case, you ‘sell’ the volatility by selling both a put and call option.

A CFD provider will typically provide an option like ‘Daily ASX 200 4310 call’. ‘Daily’ represents the length of the option, ASX 200 indicates the market, 4310 represents the stock index level and call the type of option. To sell the volatility, you would sell both this option plus the relative put option.

If the premiums to exercise the options were 28 and 30 respectively, it would give you a total premium of 58. This is your ‘straddle’. When selling volatility, in this example, so long as the ASX 200 did not deviate 58 points from its value of 4310 in either direction by the close of play, you would have made a profit. This allows you to take advantage of a market with low volatility. It must be remembered, however, that your potential loss in this example is unlimited, as for every point the ASX 200 travels out of the 4310 +/- 58 range, you would lose money.

If you are still left wondering ‘what are options?’ and how you can study the underlying markets, visit IG Markets. They are a CFD provider who offer a wide range of options across the markets, as well as market analysis and educational seminars to help you plan your trading.

Please consider the Product Disclosure Statement available from IG Markets. The above information should not be interpreted as financial advice. CFD trading can result in losses that exceed your initial deposit and you do not own or have any interest in the underlying asset. Please make sure you understand all the risks before investing.