Low-Volatility Options Trading Strategies

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.

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.

• 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.

• 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.
 

• 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.
 

• 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.

• 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.