This article shall give six common sense-actions based on both implied volatility and the market’s trend direction. First, bullish scenarios will be looked at and then Bearish ones. Within each scenario there will be three subgroups; i.e. Strongly Bullish, Moderately Bullish, & Slightly Bullish.
The tables in all of the figures follow the same format. Starting on the left, Market Bias, Stock Action, Option Action, the trade Risk, Reward, and in Bold Letters the I.V. reading.
Market Bias
Stock Action
Option Action
Risk
Reward
Implied Volatility
Strongly Bullish
Buy the stock
Buy a put (+p)
Limited
Unlimited
Low
Figure 1: Bullish with the low IV
The scenario that matches figure one includes the mindset of a trader who is very Bullish on the underlying yet at the same time wishes to have some protection for the duration of the trade. The re-requisite actions prior to both purchases, stock and put options, is to verify whether the I.V. is low. It is then that the trader can proceed by simultaneously entering into this protected Bullish position. The fact that he purchased both the stock and the put means that there are no limits to his upside potential. If the stock goes up, the value of the put decreases yet the trader already accepted the cost of the put as a way of insuring the long investment. Nevertheless, if the stock tanks a lot then every penny paid for the put would be viewed as a smart investment. Figure 1 can be compared to owning a car with the insurance on it.
Market Bias
Stock Action
Option Action
Risk
Reward
Implied Volatility
Bullish
Buy the stock
+p and also -c
Limited
Limited
Mid Range
Figure 2: Bullish with the IV in the middle… Continue Reading
