Volatility is one of the financial markets' most integral and inseparable elements. Every investor must attempt to understand it and find out how it affects the instruments you want to trade. It will help you make profits from your trades, given the conditions prevailing in the financial markets. The individual stocks and markets are always modifying themselves from periods of high volatility to low volatility. We need to find out how to time our strategies to factor in such fluctuations. When discussing volatility in the financial markets, they usually refer to implied volatility. It looks toward the future and finds out how the movements will be in the future volatility of a stock. It informs investors how the instrument is going to move. With this information, investors can create implied volatility trading strategies. This statistic is shown on an annual basis and is non-directional in nature. The more the implied volatility, the more investors think that the share price will move.
The shares listed on the Dow Jones are usually value stocks, so a lot of fluctuations are usually not expected. So, they have lower implied volatility. The small-cap or growth stocks on the Russell 2000 always keep moving around, so they have higher implied volatility. When trying to find out if you are in a low volatility or high volatility market, you should always look towards the implied volatility of the S&P 500. It is also called the VIX. The usual price of the VIX is twenty. Thus, any figure above that level would be seen as high, and anything below that would be low. When the VIX goes above that number, the focus of the investor shifts into short options, becoming the net sellers of their options instruments. Then, the implied volatility trading strategies used are naked calls and puts, iron condors, strangles, and short straddles. The main thing with selling options in such high volatility is that you should wait for it to reduce before executing the trades. Do not try to go short on options as the volatility is increasing. You should be patient and wait for it to come down so the strategies can be successful.
Hedging is crucial to take any part in the financial markets. A trader can hedge a portfolio by purchasing a bear put spread or a nifty put. After determining their portfolios' composition, they can use long-dated options or monthly contracts. This hedging exercise depends upon the type of shares in the portfolio and the beta. For instance, in any portfolio with a large-cap Nifty name, it is quite easy to calculate the beta and plan your implied volatility trading strategies compared with small-cap and mid-cap names. For any portfolio with only mid-cap names, a person needs to find the right asset to perform their hedging. Also, they need to monitor their positions, exit points, and the correct quantity and strike for the spread. A person should also keep in mind that the mitigating risk or hedging does not take place without having any extra costs. They should also remember that various instruments have different beats. There are times when the perfect hedging may not be possible. Still, partial hedging also assists in securing the existing position.
When there is a bear market, going short on futures gives a chance to investors when many of the diluted shares go down a lot. It is always better to be with the trend till it stops trending. In any weak market trend, the usual short position should be more than taking on a long position. You can opt for a top-down approach. An investor can find out about the diluted shares and sectors in the financial markets to start shorting ideas to get some alpha in the financial markets. Bear put spreads and put buys that are specific to some shares can also assist in getting the chance during the corrective phase in the financial markets. The best strategy here is to choose a share that has a weak structure. Any trend line breakdown and moving average with crossover are some of the usual trading indicators used to find out the shares to stock. Another derivative indicator to find out shares too short is based on open interest addition, which has a short build-up and then a long unwinding. It can be lower put-call ratio shares and higher call writing.
Going short on call options is one of the most preferred implied volatility trading strategies that decrease the cost of holding positions and makes more profit on the trades taken. For this, the investors need to find the shares to do put or option writing based on certain liquidity and maintaining some safety while writing the strikes. The strike price can also be based on the sufficient premium yield and the buffer. Investors should try to monitor their positions by placing some alerts in the system that will assist them in deciding the trading or exit mechanisms. Call writing gives some inflow as a premium. But a larger increase in the shares beyond the original strike may not help give the required return. This strategy is more suitable for people who want a consistent reduction in cost and some percentage of profit scenarios.
The volatility typically remains high when the financial markets have an overall outlook that is bearish. This also remains true for the options premium and the increased market risk. Such option writing is not advised in scenarios when the implied volatility is higher, even when the premium of the options is high. It is advisable to go with strategies such as Iron Condor and Butterfly rather than only going short on out-of-the-money puts and calls. Buying or selling any future instruments should also be hedged with protective calls to remove any risk. This will help to avoid any sudden margin calls. The investors are advised to settle a majority of their naked positions intraday and not carry a lot of leverage until the VIX does not go down to their level of comfort. The best tool for long-term investments in the financial markets is fundamental analysis. Also, technical analysis is the main tool for traders to make profits in trades in the markets that continue to evolve.
You can also opt for pair trading. It gives the investor a higher edge in some particular market scenarios. This is because many pairs of shares of different firms are highly correlated, and they give chances to get gains from them when they move away from their mean. The risk is quite low in pair trading. This is because both the shares have short and long exposure in the financial markets.
Implied volatility trading strategies are important because declines and increases are integral to making any financial market investments. All the stages in the financial markets have their own nature. They need the right method and mindset to increase profits and restrict the losses in any trades that investors take. Often, investors get into the illusion that with a lengthy period of stagnation and correction, they will come out with net profits. But it often leads to negative portfolios. Several investors in the financial markets may not believe so, but profits are not linear and come in lumps. Many investors in the financial markets take part only on the buy-side and do not have a plan to safeguard their portfolios against any probable swings in the financial markets. This leads to performance that is below satisfactory for them. In this article, we have given some useful implied volatility trading strategies that will help investors to navigate through the markets when they are volatile.