Technical Indicator MEGA Reference Part 12 – Bollinger Band® Option Volatility Strategy

Read The First Part, Second Part and Third Part Before Proceeding

Option Volatility Strategies

There are two basic ways a trader might trade volatility:

  1. Traders try to buy options with low volatility in hopes that volatility will increase and then sell back those options at a higher price.
  2. Traders attempt to sell options with high volatility in hopes that volatility will decrease and then buy back those same options at a cheaper price.

Since Bollinger Bands® adapt to volatility, Bollinger Bands might give options traders a good idea of when options are relatively expensive (high volatility) or when options are relatively cheap (low volatility). The chart below of Wal-Mart stock illustrates how Bollinger Bands might be used to trade volatility:

Potentially Buy Options when Volatility is Low

When options are relatively cheap, such as in the center of the chart above of Wal-Mart when the Bollinger Bands significantly contracted, buying options, such as a straddle or strangle, could potentially be a good options strategy.

The reasoning is that after sharp moves, prices may stay in a trading range in order to rest. After prices have rested, such as periods when the Bollinger Bands are extremely close together, then prices may begin to move once again. Therefore, buying options when Bollinger Bands are tight together, might be a smart options strategy.

Potentially Sell Options when Volatility is High

At times when options are relatively expensive, such as in the far right and far left of the chart above of Wal-Mart when the Bollinger Bands were significantly expanded, selling options in the form of a straddle, strangle, or iron condor, might be a good options strategy to use.

The logic is that after prices have risen or fallen significantly, such as periods when the Bollinger Bands are extremely far apart, then prices might begin to consolidate and become less volatile. Hence, selling options when Bollinger Bands are far apart, potentially could be a smart options volatility strategy.

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