Option Volatility

One thing that many beginning options traders fail to fully understand is the importance of volatility. Volatility can have serious implications for the options strategies that they are considering. A good portion of the blame for this problem rests with poorly-written books on the subject, many of which present options strategies as singular, fixed concepts rather than as flexible tools which must shift depending upon the markets. If you’re trading options and you ignore volatility, though, you’re likely to be in for a big surprise sooner or later.

This tutorial aims to show you how you can incorporate the big “what if” situations regarding volatility into your options trading. Movements of the underlying price can work through Delta (that is, the sensitivity of an option’s price to changes in the underlying stock or in the futures contract), then impacting the bottom line. Volatility changes can also do this as well. We’ll explore the option sensitivity Greek known as Vega, which many traders are not fully aware of.

Think first, trade second

A downfall of many options traders is that they look toward those strategies they believe will provide quick and easy profits without too much thinking or research. In actuality, though, spending more time thinking and less time trading can make things easier in the end, though. At the same time, there are few lessons better for investors and traders than the pain of a mistake. Even the best traders have made errors which have led to losses; the difference between those traders who are ultimately successful and those who are not, though, is how they respond to and learn from those experiences.

This tutorial is designed as a practical guide for the average options trader to understanding options volatility, including the risks as well as potential rewards. First, though, we’ll take a look at why volatility is so important.