What is Volatility Trading?
Also known as swing trading, this is a favored strategy to make money no matter the market conditions
Volatility trading is different from other types of buying and selling, yet no less profitable. Standard trading tends to focus on the price of shares. Volatility trading, however, takes advantage of extreme price movements within the market. This trading style is also known as swing trading.
When most traders use the phrase “volatility”, they’re referring to the rate move of a stock. The more price movement, the higher the volatility. Volatility is measured in both gains and losses.
What is volatility trading? We’ll break it down below- as well as how to start earning money by investing in volatile markets.
Swing trading is risky
Volatility implies possibility. The more movement on a price, the more possibility to earn. However, there is a not-insignificant risk that you could lose out if you don’t move quickly. Risk isn’t always a terrible thing, however. In most cases, the higher the risk, the higher potential reward. Every investor must decide for themselves how much risk they can tolerate.
Here’s how to track that risk
Risk can be tracked using different volatility indexes. The Chicago Board Options Exchange’s CBOE VIX is what is commonly referred to as the volatility index. Many, many investors use it as a tool to calculate market timing. However, the way the VIX works is not widely known.
The VIX is derived from a weighted calculation of the prices from several S & P index options. The term implied volatility refers to the expected volatility of underlying securities. The VIX index focuses on the price volatility of options marks, and not of the index itself.
If implied volatility is expected to be high, then option premiums will also be high. The opposite is also true- if implied volatility is expected to be low, then option premiums will be low. When investors see option premiums increase, it is assumed that the stock index will see higher volatility as well.
At its core, the VIX volatility index attempts to quantify and measure fear in the markets. It reflects investors’ near-market volatility predictions. The general rule is that the VIX goes up when the market is tumultuous and goes down when investor anxiety is also down.
One option is to trade VIX index options and futures directly through the CBOE. This will allow you to invest in the ups and downs of the market within a well-defined section. No matter how the market goes, volatility trading will allow you to make profits by trading during market swings.
How to make money with swing trading
If an investor thinks the market is going to become more volatile, and they would like to take advantage of it, they start planning their trades. An investor might buy a VIX call option if they believe that the market volatility will go up. Or they might buy a ‘put’ option if they think that the volatility will decrease. In general, the same can be done with futures. It is entirely possible to do volatility trading with a futures contract.
One common swing trading strategy
There are a few different trading strategies you can use during volatility trading. Here is one of the most common, for when you expect market volatility to rise. The strength in this strategy is that it will minimize loss if your predictions are incorrect.
When you expect volatility to rise
When you expect volatility to rise, one strategy is to buy a call option and a put option on the same security. The two options must have the same maturity date and strike price for this strategy to work correctly.
This strategy uses both an “out of the money” call option and an “out of the money” put option. “Out of the money” generally means that an option has no current intrinsic value. For example, if you have a $3 call option – the right to buy a stock at $3 – but the stock is trading at $2, the option is out of the money. After all, why would you exercise an option to buy a stock at $3 when you could simply buy it for $2 on the free market?
You can use this strategy- often called a ‘strangle strategy’- as a safer alternative to a long straddle position. Though it will carry with it less risk than the ‘long straddle’ strategy, you will need a higher level of volatility to earn money.
In conclusion, swing trading can be a profitable way to make money with the markets. One of volatility trading’s primary strengths is that it is possible to earn money using this strategy regardless of market performance. All that matters for this strategy is that there is movement.
While volatility trading is certainly not for everyone, there are many investors out there that use it to make money. In the end, only you can decide what level of risk you are comfortable with.