These wild weeks have caused implied volatility to increase in the stock market. As you have probably seen, we were initially able to capitalize on these swings. However, as the volatility continued the options prices soared.
Why Did Options Prices Increase?
There are several factors which account for the pricing of options, but implied volatility is an important topic. In beginners’ terms, if the market is expecting higher than normal volatility, your options contracts will reflect this. Thus, making the cost to purchase options substantially higher than usual. You could look at this two different ways. One being the cost to play is temporarily higher, or two being this increases our risk.
Implied Volatility & Risk
The first scenario is fairly simple, but why would implied volatility increase our risk? If the market has large swings (increased volatility) already priced into the contracts, and the movement is not as large as expected, implied volatility will fall. This is excellent for individuals who have not yet purchased their contracts. However, if you recently purchased, you are now losing money. Inversely, as mentioned above, as implied volatility decreases so does the options contracts (which is obviously not good if you already own it).
Risk Off Approach
I have a risk off approach when it comes to trading. If the cost to purchase a contract is substantially higher than average, I’m not taking the unnecessary risk. I have traded a handful of times in the last few weeks. However, while we are all stuck at home, during social distancing, this is a perfect time to focus on strategy and study on how to become a better trader. We are constantly learning, at Slater Trades. Not only to benefit our trades, but to benefit our trading community, as well. Please check out our trading course if you would like to learn more about trading stocks & options. Additionally, please check out our private chat group, where traders share their ideas of market conditions, specific stocks to watch & more!
Stay safe out there!