Question

You are (almost) convinced that the aggregate market is going to exhibit low volatilities over the next 3 months. You are considering a bet on the low volatility. On the one hand, you want to establish a trade to take advantage of low volatilities. On the other hand, you don’t want a strategy that will result in large losses should the volatility rea3lly go up over the next few months. What would be a good options strategy in this case? Briefly discuss when you would make profits and in what situations would you incur losses? You can look up SPY and index option quotes online; use these numbers to explain your strategy.

Answer 1

One of the strategy which an investor should undertake when he is expecting that there would be a law environment of volatility in next few month would be strategy of "covered call".

Covered call is a strategy of buying the underlying stock and selling the out of the money call option of the same stock. In this type of strategy the trader is sure that there would not be any kind of volatility in coming months so he wants to eat the premium of the out of the money call option and if by any adverse reasons, it goes up and he loses on the value of call option, he would be getting through the gain in the value of portfolio stock so he would not be losing much as the loss of the call option would be nullified through the gains of the portfolio underlying stock.

So this is a completely hedged strategy and this is highly safe as the risk is also limited and this can be played in a low volatility scenario by eating up premiums.