Stock And Options Strategies For Volatile Markets

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For those who are agile enough, volatile markets offer traders many opportunities to score quick profits.

However, if you aren’t prepared to trade a quick-moving market, it can also mean getting run over.

In this article, we’ll look at a few stock and options strategies for volatile markets that can that can help traders take advantage of the opportunities while minimizing risk.

General Stocks And Options Strategies for Volatile Markets

When the market is moving quickly, it’s easy to lose sight of everything else going on. After all, you’re focusing on your positions, exits, entries, and potential new trades. But don’t forget about the major indexes and larger stocks that can move the market.

How are other indexes and larger stocks performing? Should you be concerned that a larger stock has upcoming earnings? Is there an FOMC meeting within the next few days? All of these events can increase volatility even more. Trading around those events can mean sizing down or closing out some vulnerable positions.

The strategies in this section apply whether you are trading stocks or options. Rather than strategies, they’re more like tactics. In other words, you can integrate them into any strategy.

Smaller Positions

In volatile markets, prices move quickly. There’s a few ways to compensate for that when adding new positions. But one of the most tried-and-true stocks and options strategies for volatile markets is to reduce position sizing. 

For example, if you normally trade 100 stock shares or 10 options contracts, maybe go with 75 shares or 7 contracts. Depending on how fast markets are moving, you might reduce sizing even further. 

A common rule of thumb is that traders with smaller accounts should never risk more than 1% to 3% of their account on a single trade. And the more volatile the market, the closer to 1% you’ll probably want to be.

In a $10,000 account, sticking to a maximum position size of 1%, means that you’d never risk more than $100 on a given trade. Yes, that means that you won’t profit as much if your position increases by 20%. But it also means that you’ll lose a lot less if the trade quickly goes against you by 20%.

Wider Stop Losses

Stop losses don’t tend to work too well with options. This is because of the wide “bid x ask spread” that is present in many options. The same is true of low-liquidity stocks. 

But for liquid stocks that have smaller bid x ask spreads, a wider stop loss can work better. So, for example, instead of placing a stop loss 1.00 point away from an entry, maybe consider 1.50 or 2.00 points.

Scaling In And Out

Scaling into a position provides the potential for a better price. For example, if you buy 100 shares of stock with a limit at 97, only to see the stock go down to 90 because of volatility, you’ve missed a great entry price.

We can’t know the future. But in a volatile market, those kinds of moves are common. That you can know. To compensate for fast price movements, why not go in with:

  • 50 shares at 97
  • 30 shares at 95
  • 20 shares at 93

You may not get 90, but your cost basis will be lower than 97. Also, you may only get 50 shares at 97 if the price never reaches 95. That’s ok too, since you were prepared for lower prices but ended up with a smaller position, taking advantage of the first point mentioned above.

This also works the other way. When exiting a position, rather than selling all shares at the same price, consider spreading the shares out over several prices.

Stock-Specific Strategies For Volatile Markets

Charting tools can be a tremendous help during volatile markets. It may seem like a stock is randomly swinging back and forth. But after examining the charts, you may identify patterns and support and resistance levels. 

Also, using breakdowns and breakouts to inform your trade timing works better with stocks than options.  A breakout is usually when the stock price moves up and out of a range. A breakdown is moving below and out of a range. Both are preceded by consolidation or a range-bound period.

In the chart below, we see two recent breakouts for Coke (COKE).

stocks and options strategies for volatile markets

Breakouts and breakdowns can work better in volatile markets because of how quickly prices move. However, it can still be just as tricky to trade since a fake-out is always possible, which is again where position sizing can help.

Option-Specific Strategies For Volatile Markets

Single-leg (buying or selling one option) trades can allow traders to go in at a price away from the current stock price. This provides for some margin of error and lets the price move around more. 

As an example, ABC stock is trading at $80. A call buyer decides to buy the 85 strike for 0.70. This option will need to go above $80 for the strategy to make money. In a volatile market or a stock with good momentum, both can be an advantage for this type of trade.

Using the same stock, another trader sells the 78 strike put for 0.75 because he believes the stock will also rally. As the stock remains above 78, the put seller will make money. As the stock climbs, the 0.75 option premium decreases to 0.20. The put seller decides to close the trade, collecting $55 per contract (0.75-0.20).

A multi-leg approach, which consists of two or more options in a single position, offers various ways to take advantage of volatility when trading options. For example, if a particular stock is moving around wildly, an options trader can utilize a straddle. The straddle will make money as long as the stock moves above or below a certain price area.

On Sep 10, TSLA was trading at 752. A trader buys the Sep 24 put and call:

780 Call @ $8.82
720 Put @ 11.72
Total cost: $20.09

In this case, the profitability of the trade is dependent on TSLA moving away from 752 in either direction.

Straddle Options Strategy (1)

If TSLA is at 795 on Sep 16, the trade will make $30.10. And If TSLA is at 710 on the same date, the trade will make $31.40. The main premise of the trade is that TSLA is a volatile stock and likely to move into one of the trade’s profit zones. 

Final Thoughts

Volatile markets require lots of concentration and a big toolbox (i.e., strategies and tactics). The more strategies you learn with both stocks and options, the better prepared you’ll be to dive in rather than being forced to the sidelines.