How to Profit Amid Low Volatility

05/04/2011 10:52 am EST

Focus: OPTIONS

Don Kaufman

Co-Founder, TheoTrade

Typically, periods of low volatility are less attractive for option traders, but thinkorswim's Don Kaufman shares some ideas for profitable option strategies that can be implemented during these periods.

Even as the market has been rising, volatility has remained relatively flat and low compared to historical levels. Our guest today is Don Kaufman to talk about option strategies you can use in low-volatility environments. 

Don, talk to us about how you can still make money with options even though volatility is low.

Absolutely, so you have to look at this in a couple of different fronts. Low volatility, typically for option traders—I should say historically for option traders—it hasn’t been an exciting time to trade options, that is, in the past. 

But there’s still a lot of great strategies you an employ in a relatively low volatility climate. However, they’re not always crowd pleasers out there, such as the calendar spread, which is a multi-month spread. 

Ultimately, what a calendar spread is about is it makes you net-long volatility. That, in essence, is what a calendar spread does, and a lot of option traders might not be familiar with that, but when you say “net-long volatility,” what does that entail? 

The trade itself is a volatility-sensitive trade. It simply means if volatility rises, that calendar spread literally appreciates in value, corresponding to, again, volatility increasing. 

So do you expect volatility to increase here? I mean, the markets keep increasing, at some point volatility has got to get a little bit higher, doesn’t it?

You know, I’ve been thinking that month after month after month. I mean, we’ve seen in just recent times an absolutely parabolic upside move; really one-directional. The market has flown up month after month, and of course, with that you’ll see lower volatility. 

Will we see some higher volatility? Absolutely, some time in the future. It’s just hard…picking volatility’s direction is just like picking the market’s direction. I mean, with one large news event to hit the marketplace, absolutely we’re going to see a huge spike within volatility.

You mentioned kind of an indirect way to be long volatility. What about outright trading options on the VIX itself?

I’m not that much of an advocate of Volatility Index (VIX) options; never have been. 

The VIX is a very convoluted product to most of the retail world. It’s like trading a commodity product out there. It becomes extremely confusing, as it’s an inverse-related product. 

How about just trading options on stocks that are moving, but because volatility is low, maybe they’re not moving as much as the underlying. Is that a point of frustration for a lot of traders?

Sure, I mean, obviously, with lower volatility, we’re not getting the big intraday moves.

We’re also seeing a lot of clients now migrate in this lower-volatility climate back to some of the major index products. You see a lot of activity around major indices because they find it…you know, hey, Apple (AAPL) is a great product, and you know a huge number of clients out there in the industry trade Apple. 

That being said, they’re looking back at products like the S&P 500 (SPY), trading things like S&P 500, or a Russell 2000 (IWM) out there. Only because the volatility of those particular underlyings—the major indices—is similar to that of the rest of the industry. 

They’re looking and saying, hey, you know, Apple and a lot of these different underlyings, they have to pass through earnings and pre-announcements and different news announcements.

Meanwhile, some of the index-related products didn’t have those announcements, yet the volatility in them is for the most part the same.

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