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 a Put and Implied Volatility

Example:                 XYZ stock is trading at $24 

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

Possible strategy:    Buy 1 XYZ 20 strike put at $1.00

 

Potential Profit Outcome Examples:

A) Bought 1 XYZ 20 strike put at $1.00

  • Earnings out and XYZ Stock goes from $24 to $21
  • Volatility drops from 50% to 35%
  • 20 strike put goes from $1.00 to $1.40

Even though the stock declined $3, a 15% decrease in volatility has suppressed the value of the put option. 

B) Bought 1 XYZ 20 strike put at $1.00

  • Earnings out and XYZ Stock goes from $24 to $21
  • Volatility drops from 50% to 48%
  • 20 strike put goes from $1.00 to $3.10

The stock declined $3 and volatility decreased by only 2%.  The put increased in value by $2.10 with the downward 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.