How can you effectively grapple with volatility shifts as an options trader? What moves make the most sense when volatility is high, low or flat? This post explores one trader’s real-world dilemma and provides effective ways to factor volatility into your trading plan.

I’m nearing the finish line in my blog series on volatility in options trading, but I’m eager to field any rubber-meets-the-road questions from traders. As every trader knows, theory in the markets is one thing, but practice can be quite another. Consider this volatility-quandary put to me by TradeKing client chiragshah80:

“I recently had a loss in a LEAP option where the volatility evaporated. I lost a lot of money. So can you tell me whenever there is high volatility is it good to sell the volatility or own the volatility? The same case with low volatility: is it good to sell iron condors when the volatility is low?”

Hello Chiragshah80,

Unfortunately, there’s no 100% golden rule for what strategies make the most sense under high- or low-volatility conditions. The bigger question you should ask yourself is this: what’s your forecast for volatility over the life of the trade?

If you feel uncertain about what will happen to volatility going forward, consider strategies that are more volatility-neutral. For example, if upcoming volatility changes are a toss-up, you might be better off using long spreads for a directional trade, instead of buying an option outright. Spreads can be tweaked to have a directional spin, but they can also provide a useful counterbalance if volatility suddenly shifts on you. Usually volatility will help one leg of the trade and hurt the other one, so, with proper management, it tends to balance out better than a single-leg option.

(As always, don’t forget that spreads and iron condors are multiple leg option strategies that involve additional risks and multiple commissions, and may result in complex tax treatments. Be sure to consult with your tax advisor before engaging in these strategies. Second, while implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.)

As far as iron condors are concerned, if you sell them when implied volatility (IV) for the underlying is low, you’ll probably have to narrow the range between the short strikes to receive a decent credit. If the underlying IV is high, you may be able to increase the range between the short strikes and still get the same credit.

So it’s all relative: the ideal time to sell an iron condor is when IV is high and you think it will be going lower after the trade is in place. But be careful: if the IV is TOO HIGH, that probably means something is going on in the marketplace. You should make it your business ASAP to find out what the news may be, so you don’t get burned unawares.

Check out the rest of my volatility posts, and if you’re an advanced trader looking to learn about iron condors, All-Star commentator “Doc” Maher is running an excellent blog series about those – check out his latest, on iron condors and IV, here.

Regards,
Brian Overby
TradeKing's Options Guy
www.tradeking.com

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