Strategies

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Weekly Strategy Discussion

The Weekly Strategy Discussion is designed to assist individuals in learning how options work and in understanding various options strategies. Options involve risk and are not suitable for all investors. The strategies discussed are for educational and illustrative purposes only, and should not be construed as an endorsement, recommendation or solicitation to buy or sell securities. Commissions, taxes and transaction costs are not included. Please contact a tax advisor for the tax implications involved in these strategies.

Buying Calls and Implied Volatility

Example:                 XYZ stock is trading at $21 

Outlook:                  You anticipate good earnings in XYZ stock and if your outlook is correct you would like to take advantage of a significant price increase.  

Possible strategy:    Buy 10 XYZ 25 strike 30 day calls at $1.00

Potential Profit Outcome Examples:

A) Bought 10 XYZ 25 strike calls at $1.00

  • XYZ Stock goes from $21 to $24
  • Earnings out and volatility drops from 50% to 35%
  • 25 strike calls go from $1.00 to $1.40

Even though the stock advanced $3, a 15% decrease in volatility has suppressed the value of the call options. 

B) Bought 10 XYZ 25 strike calls at $1.00

  • XYZ Stock goes from $21 to $24
  • Earnings out and volatility drops from 50% to 48%
  • 25 strike calls go from $1.00 to $3.10

The stock advanced $3 and volatility decreased by only 2%.  The calls increased in value by $2.10 with the upward move in the stock.

In Summary: When planning trades it is important to understand the affects of volatility.  Volatility up, Call and Put prices up. Volatility down, Call and Put prices down.

 

 *All values shown are at the time of expiration. Commissions and other trading fees not included.

CBOE Volatility Index (VIX)