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Advisor Knowledge Center

Myth #6: The best way to play a volatile stock is to buy call options, put options, or even both.

Fact: Buying options is not necessarily the best way to profit from a volatile stock. Investors must keep in mind that options will be priced according to the volatility of the underlying stock. Generally, a relatively stable, low-volatility stock will have relatively inexpensive options; a more volatile stock will have much more expensive options due to the greater uncertainty about future stock prices. The stocks historic volatility will be taken into account in the options’ pricing. Investors buying options to take advantage of a volatile stock must remember that the options market has taken this fact into account also. The resulting option prices will usually include a premium for that historic volatility. If the underlying stock does not behave in the future with as much price volatility as expected, this “volatility premium” in the options prices will erode, sometimes dramatically.

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CBOE Volatility Index (VIX)