When volatility spikes the economic doom merchants always seem to come out of the woodwork. The fear-mongers decry high volatility, as it is usually associated with falling prices. This means that the majority of share portfolios will usually diminish in value in the short-term during a rise in volatility. During these periods though, traders can utilise ETOs (Exchange Traded Options) as way to trade the greater velocity of price movements. In addition, during periods of volatility, options premiums also rise (cet. par.) leading to further profitable opportunities.
Many doomsayers have successfully picked the few occurrences where our market has collapsed. However, considering their view rarely changes, they have to get it right at some point. Economic fear-mongering is the investor’s contribution to sensationalist media. It generates webpage views, circulation and advertising revenue.
Market commentators tend to be descriptive; they look at what has happened and seek to explain it. This usually means that they will be most negative at a cyclical trough and most positive at a cyclical peak.
In reality, asset prices and volatility are roughly cyclical. So always be careful when listening to analysts decrying price volatility and telling you to stay out of the market, they may cause you to miss profitable opportunities.
Volatility is an important component of options prices. When volatility rises, option premiums also rise, (cet. par.). This means that for holders of options, the value of bought/debit positions will increase with rises in volatility (cet. par.).
Additionally, high volatility can also mean great entry prices for certain options strategies. Options strategies that provide a credit will generally provide a larger credit when volatility is high. Entering these trades during peak volatility is often a sound strategy, with the cost to close the trade declining with volatility (cet. par.).
Furthermore, higher volatility will mean a greater magnitude of directional price movements. This ensures that trades based on price direction can have greater (or quicker) profitability during, and shortly after, periods of high volatility (as underlying prices move more drastically); assuming the outlook on price movements was correct. There are also options strategies that can trade outlooks based purely on changes in volatility, allowing options traders to trade the metric itself and not necessarily the direction of price movements.
Always be careful when listening to analysts who tell you to stay out of the market or reduce exposures when volatility is high. Often it is the best time to enter the market, especially from the perspective of an options trader. It is always worth keeping in mind the old adage: buy when volatility is high. Some of the most profitable trading opportunities will arise due to, and during, periods of high volatility.
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