'Buying volatility' is an options strategy that allows you to take advantage of future volatility levels.
Buying and selling volatility using options
If you believe a market is going to be volatile on a particular day, or over the next few weeks, you can advantage by betting on the volatility itself even if you aren't sure which direction the market is going to move.
Take a look at our examples to see how you can bet on volatility with options:
'Buying Volatility' on the FTSE®
The FTSE® is currently up five points on the day, trading at 5300. You know there is important US payrolls data due out at 13:30. You believe the FTSE® will have a big move once the US data is announced but you are not sure whether it will move up or down. In this example your risk is strictly limited.
You decide to 'buy' Daily FTSE® options to take advantage of the expected volatility, and you 'buy':
£10 of the 5300 call at 14, and
£10 of the 5300 put at 16
This is called a Daily 5300 FTSE® Straddle.
Because you have paid a total of 30 (14+16), you need the FTSE® to move 30 points away from 5300 in either direction (5270 and 5330) to break even. For every point further the FTSE® moves you make £10 per point.
So when the US payroll data comes in, if the FTSE® moves higher and finishes at 5372, you make 42 points overall:
5372 (final FTSE® level) – 5300 (opening level) – 30 (the total premium you paid buying the call and put) = 42.
Because you bought £10 per point your total profit is £420 (42 x 10).
In this example, your worst-case scenario would be if the FTSE® was unaffected by the US payrolls data, and finished at 5300. If this happened you would lose £300 [£30 (premium) x 10 (stake)]. This £300 represents your total risk on this position.
'Selling Volatility' on £/$
Options can also be used to effectively 'sell' volatility, allowing you to profit from your view that the FTSE® (or any other market) will not have a big move on a particular day.
If you believe there is unlikely to be a significant move on £/$ on a particular day you can back your view by 'selling' Daily £/$, either individually (by 'selling' a call or put) or as a Straddle ('selling' a 'call' and a 'put'). For example, the price of a £/$ 16600 Straddle when £/$ is 16602 is priced at 52-55 for the call and 50-53 for the put.
You believe it is very unlikely that £/$ will move more than 102 points before the expiry and so choose to 'sell' both the Daily £/$ 16600 call and the 16600 put:
£10 of the 16600 call at 52, and
£10 of the 16600 put at 50
You have a 'sold' a 'Daily 16600 £/$ Straddle'
Because you have 'sold' at a total of 102 (52 + 50), you need £/$ to finish within 102 points of 16600 to finish in profit. For every point outside this range, ie under 16498 (16600 - 102) or over 16702 (16600 + 102) you will lose £10 per point.
In this example, the best-case scenario is that £/$ does not move and closes at 16600 – whereby both options finish worthless and you make £10 x 102 = £1020. It is important to understand that when selling options your risk
Spread bets are leveraged products. Spread betting may not be suitable for everyone and can result in losses that exceed your initial deposit, so please ensure that you fully understand the risks involved.