The market has been very volatile over the past couple of months. It’s true that sometimes market movement occurs at times without volatility events. But cognizant traders and investors need to be ready when they know a volatility event is coming. Here are a few easy things to do to be prepared.
Use Collars for Protection
If you are an investor, you can always implement a collar to protect your stock position for 100 shares or more. A collar is selling a call option (usually out-of-the-money) and using the proceeds to help fund buying a put (usually OTM too). A collar is used for protection. Too many investors get confused and think it is an option position meant to make money. It can, but its purpose is to potentially offset the price of a decline in the stock price. And even though the owner of a put option has the right to sell the shares, he or she does not have to. They can simply sell the put option and buy back the short call position. This can offset the value of the shares if the shares decline in price.
Take Risk Off
For option traders with no underlying stock position, it’s even simpler. Plan to reduce size before the volatility event. It does not get easier than that! I like to say win, lose or draw, close out some if not all of the position. When in doubt, take it off! Reducing contract size, even for a loss, is so smart many times. Clearly, without risk, one cannot profit; but without risk, one cannot lose. Just be smart about it.
If you are watching the position through a volatility event, say, an FOMC announcement, you can always take some action especially if the position is not going as desired. The key is to not have on too many positions or contracts, because it can make things difficult.
Final Thoughts
Volatility does not look like it is going away anytime soon. So, if you plan to continue to trade, you might want to heed the advice above. If not, you are leaving yourself open to the mercy of the market and undisciplined trading, and that is never a good thing.
