In 2023, market volatility has remained relatively low for most of the year, characterized by slow and steady movements. However, this low-volatility environment presents both challenges and opportunities for traders.
One of the key challenges in such an environment is the prolonged holding of options positions. As time passes, the premium of an option gradually decreases, resulting in potential losses for option buyers, even if the underlying stock or index doesn't move significantly.
On the flip side, low-volatility markets offer a unique advantage – options across various strike prices and types (Call & Put) tend to have lower premiums. This means that the initial investment required to establish a Buy position in an option is relatively low in a low-volatility environment.
To make the most of this low volatility and slower market environment, traders can focus on strike selection. In options trading, strikes can be categorized into three types:
1. ATM (At the Money): The selected strike is close to the current market price.
2. OTM (Out of the Money): Call strikes are higher than the current market price, and Put strikes are lower than the current market price.
3. ITM (In the Money): Call strikes are lower than the current market price, and Put strikes are higher than the current market price.
Now, let's delve into the reasons why Out of the Money (OTM) options tend to outperform in low-volatility environments:
Reason #1: Lower Investment
OTM options, by definition, involve buying options to Buy Higher (Call) or Sell Lower (Put) than the current market price. This characteristic makes OTM options less attractive to some traders because if the underlying stock or index expires at the current level, OTM Calls and Puts will be worthless. However, in a low-premium environment, OTM options are even cheaper, making them an attractive choice due to their lower investment requirement.
Reason #2: Higher Returns on Investment
While all options move similarly for a given favorable market move, ITM options will typically experience a greater increase in premium than ATM options, and ATM options will see a larger premium increase than OTM options. When assessing returns on investment (Premium Profit / Premium * 100), OTM options tend to shine, offering a more favorable return compared to the premium invested.
Reason #3: Lower Absolute Loss
OTM options have relatively low intrinsic value, translating to lower absolute losses if the market doesn't move as expected. This aspect makes OTM options appealing because traders can limit their potential losses when sticking to a single position in a stock or index.
In summary, the combination of higher returns, lower initial investment, and reduced potential losses makes OTM options an attractive choice for trading in low-volatility environments. However, it's essential to consider individual trading strategies and risk tolerance when selecting strike prices and option types.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before making any investment decisions.
One of the key challenges in such an environment is the prolonged holding of options positions. As time passes, the premium of an option gradually decreases, resulting in potential losses for option buyers, even if the underlying stock or index doesn't move significantly.
On the flip side, low-volatility markets offer a unique advantage – options across various strike prices and types (Call & Put) tend to have lower premiums. This means that the initial investment required to establish a Buy position in an option is relatively low in a low-volatility environment.
To make the most of this low volatility and slower market environment, traders can focus on strike selection. In options trading, strikes can be categorized into three types:
1. ATM (At the Money): The selected strike is close to the current market price.
2. OTM (Out of the Money): Call strikes are higher than the current market price, and Put strikes are lower than the current market price.
3. ITM (In the Money): Call strikes are lower than the current market price, and Put strikes are higher than the current market price.
Now, let's delve into the reasons why Out of the Money (OTM) options tend to outperform in low-volatility environments:
Reason #1: Lower Investment
OTM options, by definition, involve buying options to Buy Higher (Call) or Sell Lower (Put) than the current market price. This characteristic makes OTM options less attractive to some traders because if the underlying stock or index expires at the current level, OTM Calls and Puts will be worthless. However, in a low-premium environment, OTM options are even cheaper, making them an attractive choice due to their lower investment requirement.
Reason #2: Higher Returns on Investment
While all options move similarly for a given favorable market move, ITM options will typically experience a greater increase in premium than ATM options, and ATM options will see a larger premium increase than OTM options. When assessing returns on investment (Premium Profit / Premium * 100), OTM options tend to shine, offering a more favorable return compared to the premium invested.
Reason #3: Lower Absolute Loss
OTM options have relatively low intrinsic value, translating to lower absolute losses if the market doesn't move as expected. This aspect makes OTM options appealing because traders can limit their potential losses when sticking to a single position in a stock or index.
In summary, the combination of higher returns, lower initial investment, and reduced potential losses makes OTM options an attractive choice for trading in low-volatility environments. However, it's essential to consider individual trading strategies and risk tolerance when selecting strike prices and option types.
Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before making any investment decisions.
