Explore Your Options by Price Headley
VOLATILITY VS. TREND
Should I trade options on the higher-volatility names for greater profit potential, or am I better off focusing on lower volatility for greater stability?
Certainly, the tradeoff between potential profitability and risk assumed is a personal choice. However, there’s an assumption among most option traders that trading higher-volatility names will offer more potential if they can stomach the wider swings. I recommend an alternate path.
There’s a big difference between the volatility of an underlying asset and its trend or price direction, from the beginning to the end of the time period being examined. For example, over a 20-day period, I could show you an example of a volatile stock, ABC, moving up 10% one day, down 10% the next, and in this same zigzag pattern it would make no net movement from its starting point to its ending value over the combined 20 days. Or you could choose another stock, XYZ, going up a consistent 1% per day over 20 days, with no variation. And you’d be up more than 20% net (including compounding) on the stock.
Trend traders know the answer regarding which stock to buy options on: it’s no contest that XYZ will be better for those who want a trend with that type of consistency. In the real world, no stock is that perfect, but the concept still applies. Focus on significant trends for option buying, while considering volatile trading ranges like stock ABC for your option selling strategies, like iron condors.