Why is volatility good for traders

For example, when you buy a straddle a combination of long call and long put with the same strike price , you make a profit when the underlying security moves away from the strike price realized volatility goes up or at least when the market expects better odds of a possible move away from the strike price implied volatility goes up.

If volatility does not increase, you will lose money with passing time, as long volatility positions usually cost money to maintain over time. When you are short volatility , for example you take the other side of the trade above and sell a straddle, your position makes a profit when volatility declines or when it does not increase fast enough.

When you are neutral on volatility and your position only bets on price direction e. Even when you never trade volatility directly no options, no VIX etc. Indeed, it is necessary for you to make a profit.

Volatility means how much something moves. Even if you were the best trader in the world, you would never make any profit on a stock with a constant price zero volatility.

In the long term, volatility is good for traders because it gives them opportunities. Without volatility there would be no trading opportunities and no traders. There are situations when too high volatility can be bad, because volatility goes hand in hand with risk see Is Volatility the Same as Risk?

However, in such cases it is usually the wrong direction doing the harm. The high volatility only means that the adverse move and the losses are too big in relation to the portfolio. High volatility by itself is not bad, but it can become bad when combined with mismanagement of risk typically too big positions in relation to the portfolio size. VIX at Return to Normal?

Volatility is all relative, and traders know this. But recently VIX has settled in near 20—about what it has averaged over the past decade. You see? Volatility is relative. What stood out about the late-summer turmoil was that it hit commodity markets, U. Yes, when China sneezes, the world gets a cold. Once one domino started to tip, the very real risk of panic grew. Markets were working. There are also intra-stock-market moves to be mindful of.

Sometimes traders recognize volatility for what it is—a chance to catch their breath until cooler times prevail. They know that unidirectional trading amplifies market moves—markets go up or down as a whole, rather than smaller moves among individual names cancelling one another out. Traders Have Options. One of the fastest-growing segments of the retail stock market is the use of listed options. And what makes the options market go round?

To understand how volatility affects options prices, most traders have a cursory understanding of the Black-Scholes formula, a common model used to calculate options prices. The reality is that most trading systems do the calculations automatically based on certain inputs from market makers. It can be important to distinguish between historical volatility what the market or stock has done in the past and implied volatility IV , or what is implied by the options pricing model.

For instance, a rise in implied volatility without a corresponding increase in real historical volatility is typically welcome news for the options trader. But there are other, more subtle market shifts that generate potential option strategies. Remember, the effects of IV are greater on options with more time until expiration.

The effects of IV can be minimized by combining both long and short options in a single trade, such as in a spread or condor. While puts gain value in a down market, all options, generally speaking, gain value when volatility increases. A long straddle combines both a call and a put option on the same underlying at the same strike price. The long straddle option strategy is a bet that the underlying asset will move significantly in price, either higher or lower. The profit profile is the same no matter which way the asset moves.

Typically, the trader thinks the underlying asset will move from a low volatility state to a high volatility state based on the imminent release of new information. In addition to straddles and puts, there are several other options-based strategies that can profit from increases in volatility. Technical Analysis Basic Education. Your Privacy Rights. To change or withdraw your consent choices for Investopedia.

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Trading the VIX. Volatility and Options Trading. Key Takeaways Volatility can be turned into a good thing for investors hoping to make money in choppy markets, allowing short-term profits from swing trading.

Day traders focus on volatility that occurs second-to-second or minute-to-minute, while swing traders focus on slightly longer time frames, usually days or weeks, Traders looking to capitalize on volatility for profit may use such indicators as strength indexes, volume, and established support and resistance levels. Traders can also trade on the VIX or use options contracts to capitalize on volatile markets.

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