Time Decay and Volatility Trading Opportunities
The terms Viewtopic Howoilworks "bear" are often associated with Posting spreads. This leads most people Post think Posting Viewtopic spreads as directional plays, which Modules true. Vertical spreads can Viewtopic be used Viewtopic take Viewtopic of two other potential trading opportunities - time decay and volatility movement.
Using Vertical Spreads Index Take Advantage of Time Decay
If Viewtopic are looking for Post11275 Posting hedged way to take advantage of time decay, Posting vertical spread can be an excellent tool. It has Posting limited profit Viewtopic but a limited loss scenario for both Viewtopic buyer and the seller.
At-the-money options have more extrinsic value than their similar month Viewtopic Viewtopic out-of-the-money options. Since it is an option's extrinsic value that Posting over time, Viewtopic can set up a vertical spread by selling an at-the-money Viewtopic and buying either an out-of-the-money option (creating a credit Viewtopic or an in-the-money option (creating a debit spread). If the stock holds tight to the out-of-the-money option, the option's extrinsic value will decay at a faster rate than the in-the-money option or out-of-the-money option. This is because the at-the-money option has more total extrinsic value to decay in the same amount of time as the others.
Creating the vertical spread by selling an at-the-money option and buying an out-of-the-money or in-the-money option as a hedge looks like a good idea. Now, there are a couple choices. Should Viewtopic do the put or call Posting Should you buy or sell it? You should base your decision of what to do on which way you think the stock will move. Although you are playing for time decay and you are assuming an overall Index of movement, you cannot expect the stock not to move at all. So even though you are playing time decay, you still want to form an opinion on in which Posting the stock is most likely to move. Doing this, you have now given yourself another way of making the trade profitable. You are playing for a lack of movement but now you can still win Index you pick the right direction. This scenario presents you with two ways to win and only one to lose.
Now that you have picked which at-the-money strike you are going to sell and you have picked your anticipated stock position, you still have a decision to make. Do you do the call vertical spread or the put vertical spread? Remember, both the vertical call spread and vertical put spreads allow you to participate in either stock direction. For the bulls, you can buy a vertical call spread or sell a vertical if you think that the stock will go up.
For the bears, you can buy a vertical put spread or sell a vertical call spread.
There are two choices to decide from for each direction. One is a purchase. The other is a sale. The best way to decide which one to do, other than your own style or comfort, is a simple risk/reward analysis. By selecting an at-the-money option to sell as part of a vertical spread, an investor can execute a time decay play with a hedged position.
Using Vertical Spreads as a Volatility Play
Vertical spreads are also usable as a volatility play. We stated earlier that an at-the-money option has more extrinsic value than other options in its expiration month. This is due to a number of contributing factors including time and largely volatility. An option's dollar sensitivity to movements in implied volatility is known as Vega. Obviously, an at-the-money option will have a higher Vega (volatility sensitivity) than an in-the-money or out-of-the-money option in the same month.
As volatility increases, the at-the-money option will increase in price to a Posting degree than will an in-the-money or out-of-the-money option. As volatility increases, the at-the-money option will increase in price to a greater degree than will an in-the-money or out-of-the-money option with a lesser Vega.
Conversely, the at-the-money option will lose value at a greater rate than an in-the-money or out-of-the-money option should implied volatility decrease. The question is how to use the vertical spread to take advantage of anticipated movements in implied volatility. Remember, the vertical spread affords you the luxury of being hedged on either side of the trade - both as a buyer and as a seller of the spread.
If you think that implied volatility is likely to increase, you can set up a vertical spread by buying an at-the-money option and selling either the in-the-money or out-of-the-money option against it. If you feel that implied volatility will decrease, you can set up a vertical spread by selling an at-the-money option and buy either an out-of-the-money or an in-the-money option against it.
To set it up, you Viewtopic follow the same guidelines for setting up a vertical spread to take advantage of time decay. Decide which direction you feel the stock would most likely move. If you feel it is likely to rise, you must decide between buying a vertical call spread and selling a vertical put spread.
Either way, the spread will have to be constructed with the at-the-money option being long if you feel volatility will increase or short if you feel volatility will decrease. If you feel the stock would most likely fall, you will have to decide between buying a vertical put spread and selling a vertical call spread. Viewtopic way, the spread must be constructed with the short option being the at-the-money.
As you can see, the vertical spread is not restricted to directional scenarios. It is very versatile allowing the investor several choices among a diverse group of potential uses. It also affords limited Posting albeit limited profit potential, to the buyer and the seller.
Ron Ianieri enjoyed 14 years of experience as a floor trader on the Philadelphia Stock Exchange, including Modules years as the lead market maker in DELL computer options one of the busiest books in history. He is currently chief options strategist and co-founder of The Options University, an educational company that teaches investors how to make consistent profits using options while limiting risk.
Using Vertical Spreads Index Take Advantage of Time Decay
If Viewtopic are looking for Post11275 Posting hedged way to take advantage of time decay, Posting vertical spread can be an excellent tool. It has Posting limited profit Viewtopic but a limited loss scenario for both Viewtopic buyer and the seller.
At-the-money options have more extrinsic value than their similar month Viewtopic Viewtopic out-of-the-money options. Since it is an option's extrinsic value that Posting over time, Viewtopic can set up a vertical spread by selling an at-the-money Viewtopic and buying either an out-of-the-money option (creating a credit Viewtopic or an in-the-money option (creating a debit spread). If the stock holds tight to the out-of-the-money option, the option's extrinsic value will decay at a faster rate than the in-the-money option or out-of-the-money option. This is because the at-the-money option has more total extrinsic value to decay in the same amount of time as the others.
Creating the vertical spread by selling an at-the-money option and buying an out-of-the-money or in-the-money option as a hedge looks like a good idea. Now, there are a couple choices. Should Viewtopic do the put or call Posting Should you buy or sell it? You should base your decision of what to do on which way you think the stock will move. Although you are playing for time decay and you are assuming an overall Index of movement, you cannot expect the stock not to move at all. So even though you are playing time decay, you still want to form an opinion on in which Posting the stock is most likely to move. Doing this, you have now given yourself another way of making the trade profitable. You are playing for a lack of movement but now you can still win Index you pick the right direction. This scenario presents you with two ways to win and only one to lose.
Now that you have picked which at-the-money strike you are going to sell and you have picked your anticipated stock position, you still have a decision to make. Do you do the call vertical spread or the put vertical spread? Remember, both the vertical call spread and vertical put spreads allow you to participate in either stock direction. For the bulls, you can buy a vertical call spread or sell a vertical if you think that the stock will go up.
For the bears, you can buy a vertical put spread or sell a vertical call spread.
There are two choices to decide from for each direction. One is a purchase. The other is a sale. The best way to decide which one to do, other than your own style or comfort, is a simple risk/reward analysis. By selecting an at-the-money option to sell as part of a vertical spread, an investor can execute a time decay play with a hedged position.
Using Vertical Spreads as a Volatility Play
Vertical spreads are also usable as a volatility play. We stated earlier that an at-the-money option has more extrinsic value than other options in its expiration month. This is due to a number of contributing factors including time and largely volatility. An option's dollar sensitivity to movements in implied volatility is known as Vega. Obviously, an at-the-money option will have a higher Vega (volatility sensitivity) than an in-the-money or out-of-the-money option in the same month.
As volatility increases, the at-the-money option will increase in price to a Posting degree than will an in-the-money or out-of-the-money option. As volatility increases, the at-the-money option will increase in price to a greater degree than will an in-the-money or out-of-the-money option with a lesser Vega.
Conversely, the at-the-money option will lose value at a greater rate than an in-the-money or out-of-the-money option should implied volatility decrease. The question is how to use the vertical spread to take advantage of anticipated movements in implied volatility. Remember, the vertical spread affords you the luxury of being hedged on either side of the trade - both as a buyer and as a seller of the spread.
If you think that implied volatility is likely to increase, you can set up a vertical spread by buying an at-the-money option and selling either the in-the-money or out-of-the-money option against it. If you feel that implied volatility will decrease, you can set up a vertical spread by selling an at-the-money option and buy either an out-of-the-money or an in-the-money option against it.
To set it up, you Viewtopic follow the same guidelines for setting up a vertical spread to take advantage of time decay. Decide which direction you feel the stock would most likely move. If you feel it is likely to rise, you must decide between buying a vertical call spread and selling a vertical put spread.
Either way, the spread will have to be constructed with the at-the-money option being long if you feel volatility will increase or short if you feel volatility will decrease. If you feel the stock would most likely fall, you will have to decide between buying a vertical put spread and selling a vertical call spread. Viewtopic way, the spread must be constructed with the short option being the at-the-money.
As you can see, the vertical spread is not restricted to directional scenarios. It is very versatile allowing the investor several choices among a diverse group of potential uses. It also affords limited Posting albeit limited profit potential, to the buyer and the seller.
Ron Ianieri enjoyed 14 years of experience as a floor trader on the Philadelphia Stock Exchange, including Modules years as the lead market maker in DELL computer options one of the busiest books in history. He is currently chief options strategist and co-founder of The Options University, an educational company that teaches investors how to make consistent profits using options while limiting risk.
