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Viewer Mail: A Volatility Top

I had a great question come across the comments earlier this month.

It's a little bit in hindsight as volatility has already dropped, although I did call for that move.

Here's the question;

If someone expected volatility to peak (thus market find a bottom) in the next few weeks, is it better to:

a. buy calls
b. sell puts

Selling puts have a max profit of "only" 100% while at the same time volatility will be extremely high and my thought is that volatility dropping might reduce the value of buying calls

If its going to be a long term bottom, I'd rather be a buyer of options since there will be more upside but with volatility high I'm unsure.

This is a tough question because honestly there is no right or wrong answer.

Selling puts and other short option strategies will get you long delta, short vega, and short gamma.

Buying calls and other long option strategies will get you long delta, long vega, and long gamma.

So the tradeoff here is between the gamma risk and volatility risk. I'm leaving time risk out for now.

When the market bounces, it can often be a pretty viscous bounce. Take the current rally in the $SPY - nearly an 8% rally off the lows, and volatility really hasn't gone down that much. So in this particular instance, call buying will have offered better rewards relative to the risk taken.

But there are other cases in which the market doesn't have a giant snapback rally and instead becomes rangebound as it takes time for accumulation to develop. During this time, implied volatility can head lower while the market does nothing. In this case, being a net seller of volatility will win out.

Once again, it comes down to your own personal preferences in options trading. You really do have to incorporate strategies that match your personal style and risk preferences. If you don't really know what style best suits you, consider taking my course to help you get started.

I love getting questions like these-- if you have on of your own, don't hesitate to send it my way-- you can get my contact info at the bottom of my about page.

by Steven Place

Steven Place is the founder and head trader at investingwithoptions.com/