Implied volatility and Options Strategy
Understanding Implied volatility and Options Strategy Buy low! Sell high! We've all heard of that before. Nevertheless, is it that easy to predict when prices of stocks will rise or fall? Or when is the right time to buy and sell shares of stock when there are a lot of factors already affecting your decision making skills? Throughout the century, we have seen it fluctuate so drastically that investors have become weary and cautious when dealing with the stock market. Different financial strategies and theories are “put” into good use to ensure a sound and safe albeit risky decision. One trading strategy that is ideal to use especially in a downward market is the option strategy particularly the selling of “puts”. This is because an option strategy allows an investor to generate income from premiums, leverage stock price movements and insure their portfolio. To be clear, when you buy a put option, it gives you the right to sell the stock at the pre-determined strike price. On the other hand, if you sell a put option, it gives you an obligation to buy the stock at the pre-determined strike price. You might think that selling a put option does not sound good, since it obligates you to pay a higher amount if a buyer decides to use it. However, you must take into consideration that you are selling put option on a declining market. This means you are expecting that when markets decline there is a rapid increase in volatility, which in turn affects option premiums. Implied volatility represents the expected volatility of a stock for the entire lifespan of the option. It is an important factor when using an option strategy since its rise and fall will determine how expensive or cheap the price of the option will be. Implied volatility is directly influenced by the demand and supply of options. When investors’ demand for options rises, implied volatility also increases thus make the options expensive. On the other hand, if investors’ demand for options decreases, implied volatility also decreases making options cheaper. Therefore, if you are selling puts on a declining market, there is a likelihood that demands for options would increase causing implied volatility to rise and therefore making options more expensive. Professional options traders use this as a means to gain more profit from the increase in premiums. Beginners on the other hand, can use it as a means to acquire a desired stock at a lower cost.
However, bear in mind that these are derivative instruments thus highly unpredictable. Precautions and extra care are needed since we are dealing with money matters. Selling a put will obligate you to pay the agreed price, so be sure that you are selling a put option for a stock that you want to own. In addition, investors should use an options strategy not only as a means to earn premium profit but also as a way to own stocks at a lower cost for future more profitable returns. With this in mind, you can make financial decisions that are sound and avoid the risk of using option strategy for the wrong reasons.