Low-Volatility Options Trading Strategies

August 16, 2023 Advanced
When volatility falls, option traders can seek out these five options strategies to potentially help them capitalize on lower volatility levels.

In the stock market, there are some trading periods that are highly volatile with a lot of price fluctuation, and there are several options strategies designed for such volatile trading environments.

On the other hand, there are periods when price fluctuations are not so frequent and volatility1 is low, and there are also options strategies designed for these market doldrums. Stuck in the mud. In the doldrums. Think holiday markets and the dog days of summer rolled into one.

But before we continue, a note of caution: There are no guarantees with these or any trading strategies. When options prices are relatively cheap, it's typically a reflection of low price action and a calm market. The calmer market conditions can sometimes provide potential opportunities for option traders. Here are strategies traders can consider when volatility is low.

5 strategies to consider in low-volatility markets

In general, lower volatility usually means lower options premiums. That can make credit strategies (those in which premium is collected up front) less attractive.

Here are five options strategy ideas designed for lower-volatility environments: two bullish, two bearish, and one neutral. Remember that your losses can be increased by costs, including fees and commissions, and that commissions and fees can also reduce your potential maximum gains.

1. Bullish strategy: Long at-the-money (ATM) call vertical

Image illustrates a long ATM vertical spread, showing where loss and profit might be seen, along with the long strike and short strike.

For illustrative purposes only.

  • Structure: Buy a call that's one strike in the money2 (ITM), and sell a call of the same expiration that's one strike out of the money3 (OTM)
  • Capital requirement: Usually somewhat lower and depends on the difference between strikes
  • Risk: Defined

With this strategy, traders can consider creating a vertical4 where the debit is less than the perceived intrinsic value of the long call. That will make the time decay, or theta,5 positive for this debit position. When trading, it's important to consider maximum gain vs. maximum loss. In general, with this strategy, maximum gain is equal to the spread between the two strike prices being considered, minus the debit paid. On the other hand, maximum potential loss is usually limited to the net debit paid. A trader might consider looking at expiration dates 30 to 60 days out to give the position more duration. Maximum profit is usually achieved close to expiration or if the vertical becomes deep ITM. Some traders take less than the maximum profit ahead of expiration if they can.

2. Bullish strategy: Long OTM call calendar

Image illustrates a long OTM call calendar, showing where loss and profit might be seen, along with the short strike.

For illustrative purposes only.

  • Structure: Buy a back-month OTM call, and sell a front-month call of the same strike
  • Capital requirement: Lower
  • Risk: Defined

Because calendar spreads maximize their value when the stock is at the calendar's strike price near expiration, this bullish strategy has an "up to this price, but not much more" bias. Lower volatility can make calendar debits lower. Buying one longer-term call and selling one shorter-term call offers limited gain potential, while limiting losses.

One strategy is to look for a short option between 25 and 40 days to expiration and a long option between 50 and 90 days to expiration. Some traders look for a calendar that can be profitable if the stock stays at its current price through the expiration of the front-month option and has approximately 1.5 times the debit price for maximum profit if the stock is at the strike price at expiration.

Essentially, your maximum gain will be realized if the underlying price is the same as the strike price on the shorter-term call's expiration date. On the other hand, the maximum potential loss equals the spread.
 

3. Bearish strategy: Long ATM put vertical

Image illustrates a long ATM put vertical, showing where loss and profit might be seen, along with the short and long strikes.

For illustrative purposes only.

  • Structure: Buy a put that's one strike ITM, and sell a put of the same expiration that's one strike OTM
  • Capital requirement: Lower
  • Risk: Defined

It's possible to create vertical spreads where the debit is less than the perceived intrinsic value of the long put.6 That should make the time decay positive for this debit position. Traders might consider looking at expiration dates 30 to 60 days out to give the position more duration. Maximum gain is usually defined by the spread between strike prices, minus the net premiums paid on the trade. Maximum loss is usually limited to the net premium you pay on the trade. Maximum profit is usually achieved close to expiration or if the vertical becomes deep ITM.
 

4. Bearish strategy: Long OTM put calendar

Image illustrates a long OTM put calendar, showing where loss and profit might be seen, along with the short strike.

For illustrative purposes only.

  • Structure: Buy a back-month OTM put, and sell a front-month put of the same strike
  • Capital requirement: Lower
  • Risk: Defined

Because calendars maximize their value when the stock is at the calendar's strike price near expiration, this bearish strategy has a "down to this price, but not much more" bias. 

Put calendars can potentially benefit from an increase in volatility if it increases on a drop in the stock price. When considering maximum profit, you're more likely to see it if the price of the underlying for the shorter put is higher than the strike price when establishing the position and the price falls to the strike by the expiration. Maximum potential loss is the debit paid.

Traders might consider looking for a short option between 25 and 40 days to expiration and a long option between 50 and 90 days to expiration. Look for a calendar that can be profitable if the stock stays at the current price through the expiration of the front-month option and has approximately 1.5 times the debit price for maximum profit if the stock is at the strike price at expiration.

5. Neutral strategy: Short straddle

Image illustrates a short straddle, showing where loss and profit might be seen.

For illustrative purposes only.

  • Structure: Sell an ATM put, and sell an ATM call
  • Capital requirement: High
  • Risk: The risk of loss of a short straddle is unlimited; uncovered ("naked") options strategies involve the highest amount of risk and are only appropriate for traders with the highest risk tolerance

Shorting an ATM call and put can generate a large credit even in a low-volatility environment. However, it requires greater confidence that the stock price won't change much between now and expiration. In general, the maximum profit possible from a short straddle is the premium received. This is achieved if the underlying happens to be trading at the same price as the strike on the expiration date. It's still possible to be profitable when the underlying is at a different price than the strike, but the profit is smaller because the trader only receives the full credit if the options expire worthless.

A trader might consider selling options closer to expiration (between 20 and 35 days) to maximize positive theta. A trader can also consider buying back the short straddle before expiration if profit is available.

1Volatility (vol) is the amount of uncertainty or risk of changes in a security's value. This concept is based on supply and demand for options. Higher demand for options (buying calls or puts) will lead to higher vol as the premium increases. Low demand or selling of options will result in lower vol. Vol in its basic form is how much the market anticipates the price may move or fluctuate.

2Describes an option with intrinsic value (not just time value). A call option is in the money (ITM) if the underlying asset's price is above the strike price. A put option is ITM if the underlying asset's price is below the strike price. For calls, it's any strike lower than the price of the underlying asset. For puts, it's any strike that's higher.

3Describes an option with no intrinsic value. A call option is out of the money (OTM) if its strike price is above the price of the underlying stock. A put option is OTM if its strike price is below the price of the underlying stock.

4An options position composed of either all calls or all puts, with long options and short options at two different strikes. The options are all on the same stock and of the same expiration, with the quantity of long options and the quantity of short options netting to zero.

5A measure of an options contract's sensitivity to time passing one calendar day. For example, if a long put has a theta of –0.02, the options contract's premium will decrease by $2.

6Gives the owner the right, but not the obligation, to sell shares of stock or other underlying assets at the option's strike price within a specific time period. The put seller is obligated to purchase the underlying at the strike price if the owner of the put exercises the option. In the case of an index option, it's a cash-settled transaction with no underlying asset changing hands.

Options carry a high level of risk and are not suitable for all investors. Certain requirements must be met to trade options through Schwab. Please read the options disclosure document titled Characteristics and Risks of Standardized Options before considering any options transaction. Supporting documentation for any claims or statistical information is available upon request.

Uncovered options strategies involve potential for unlimited risk and must be done in margin accounts. Spread trading must be done in a margin account. Multiple-leg options strategies will involve multiple transaction costs.

Commissions, taxes, and transaction costs are not included in this discussion but can affect the final outcome and should be considered. Please contact a tax advisor for the tax implications involved in these strategies.

This material is provided for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

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