Option Flexibility Allows Traders to Adjust Positions as Market Changes

Option Flexibility Allows Traders to Adjust Positions as Market Changes

As an options trader, I continue to be impressed by the wide variety of choices available to modify a trade that is not quite going the way I initially predicted. This approach may be a bit unfamiliar to the trader whose experience has been primarily with trading stocks. The choices for a stock trader are really only two: open or close a position.

The knowledgeable options trader can structure trades using one or more of the three primal forces of options to increase probabilities of success. These three factors are: time to expiration, implied volatility, and price of the underlying. If these variables are considered in the initial construction of a trade, the options trader can increase the probability of success of a trade. Even more remarkable is the ability to modify the physiology of an existing trade as a result of changing market dynamics.

I thought it would be helpful to examine a trade in which I have had to use several of these factors in order (perhaps) to avoid a loss. In discussing this trade which is still open, a position I have yet to know if will ultimately be profitable, you can begin to understand some of the fundamental concepts which guide an option trader's decisions.

On March 29, I saw a pattern in X which I considered to be modestly bullish. X is a very liquid stock and as often the case; this liquidity is accompanied by an actively traded options board. In considering my many choices of how to structure this position, I chose to focus on what has been the defining characteristic of the market during early 2011-the low volatility environment.

Most traders are familiar with the VIX being reflective of general market implied volatility, but when considering trade structure it is important to realize there is an implied volatility history for each underlying for which options are traded. A graphical display of such a history is embedded below.

It is clear that X is currently in its lower range of implied volatility.

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==> Option Flexibility Allows Traders to Adjust Positions as Market Changes

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