3 strategies to consider when using options in a choppy market
Finding optimal swing trades can be tricky when the stock market is chopping in a range. However, volatility option strategies that benefit from time decay can be a great choice, especially if implied volatility (IV) is high.
Various option selling strategies can do well in a choppy market because options sellers make money even when the underlying stock is going sideways. On the other hand, equity traders can easily get stopped out of trades and fail to time the sideways action efficiently enough to make a profit.
The Benefit of Theta in a Choppy Market
Option selling strategies win in all market conditions except when the actual volatility exceeds the IV priced in with options. In other words, option sellers win except when the market moves in one direction massively.
If the market is chopping and going sideways, selling options is an excellent approach since the underlying security is not moving hard in either direction. As time passes, options will slowly bleed and provide option sellers with profit. Here are examples of volatility options strategies that will profit when the market goes sideways.
Short Strangle
The short strangle strategy combines selling a put and a call within the same expiration date. If the underlying stock stays between your put and call strikes, you will ultimately make money as expiration nears.
Additionally, if you sell a strangle and the IV drops, your profits will arise even quicker. All options traders must understand volatility's massive impact on their positions. When the market is choppy, you must keep an eye on volatility to determine if options seem cheap or expensive.
Broken Wing Butterfly
The broken wing butterfly strategy is excellent for choppy markets because it is a relatively delta-neutral trade. The broken wing butterfly works with puts or calls but combines a vertical credit and debit spread. So, for example, a put broken wing butterfly would consist of a put credit spread and a put debit spread.
The trade is generally routed to a credit, meaning the put credit spread pays you more than you pay for the debit spread. Additionally, the put credit spread will be further out-of-the-money (OTM),which means it decays quicker than the debit spread and results in profits while remaining hedged.
The downside of this strategy is that you will make less when you are right. Since the broken wing butterfly is a hedged trade, it will protect you from losses and limit your gains. When the market is choppy, many traders will accept this tradeoff to increase their profitability and win rate.
Short Straddle
The short straddle is similar to a short strangle except that you sell the call and put using the same strike price. Generally, traders sell the closest strikes to the current market price of the stock -- at-the-market (ATM) strikes. However, two ideal situations can happen after you place a short straddle.
The first situation is that IV decreases after you place the short straddle. Since you are selling options, you are short volatility and are betting that option prices will decrease.
Another good outcome after placing a short straddle is the underlying stock stays in a tight range. So when the market is choppy, it will move up and down a lot, giving theta a chance to make you a profit with a short straddle.
Volatility Options Strategies for Choppy Markets: Bottom Line
When the market is choppy, there are many ways to utilize options to generate a profit in your trading portfolio. Selling options is generally the best for a choppy market because you can make money due to theta decay.
Additionally, volatility is likely to be elevated when the market is choppy. High IV allows you to make more money as an options seller since options prices will be higher than average.