Options Strategies for Low Volatility

The stock market can feel like a roller coaster, with every day bringing new information for investors to consider. However, the market can feel tame and less volatile during some stretches. Many traders enjoy volatility and thrive on sharp price swings, but option traders can also benefit from low volatility in the markets. These strategies can possibly help traders potentially increase their returns when there is less drama in the stock market.

What Does Low-Volatility Environment Mean?

Have you felt like your favorite stock’s price hasn’t budged in over a week? No sharp rallies or declines, but just a stable price? This outcome indicates a low-volatility environment. Stock prices remain relatively stable and experience smaller price changes. The stock may experience movements of +/- 0.5% each day. Daily changes of 1% and 2% won’t be as common during this time frame.

Low-Volatility Options Strategies

Most options traders get started with long calls and puts. These options can generate returns and be useful additions to your portfolio, but you might want to consider some different strategies for markets, as well as losses, with less volatility. These multi-leg strategies are more complex than buying calls and puts, but they get easier to understand once you know the basics. You can use these options trading strategies to potentially benefit from markets with less price movement. 

1. Iron Condor

An iron condor is when a trader sells a call and put and also buys a call and put. These options have different strike prices but the same expiration date. The purchased calls and puts are typically out of the money, while the sold options are typically in the money. The long call and put positions cap the trader’s losses. The premium from the sold options minus the premium paid for the long positions represents the maximum profit. 

You can initiate an iron condor by collecting a combined $7 premium from selling a call and put. The trader can buy a call and put for a combined $4 premium. This strategy results in a maximum profit of $300. The maximum loss depends on the strike price for the long call and put.

Assume a stock trades at $100 per share, and a trader initiates an iron condor with a $90 lower put strike and a $110 upper call price. The shorted put has a $95 strike price, and the shorted call has a $105 strike price. The trader in this scenario secures a $3 net premium for the call spread and a $1 net premium for the put spread. 

If the stock goes up to $120 per share at expiration, the call spread will result in a net loss of $500. That’s the difference between the calls’ strike prices. However, this loss gets offset by the premium from the put spread, which comes in at $100. Therefore, the maximum loss for this iron condor is $400 if shares exceed the higher call’s strike price. 

Strike prices closer to the money minimize the maximum loss you can incur from an iron condor. 

2. Put and Call Debit Spreads

Put and call debit spreads are similar but involve the opposite type of contract. These are the different types of spreads:

• Bullish call debit spread: Buy a call. Then, sell a call with a higher strike price than the purchased call.
• Bearish call debit spread: Buy a call. Then, sell a call with a lower strike price than the purchased call.
• Bullish put debit spread: Buy a put. Then, sell a put with a lower strike price than the purchased put.
• Bearish put debit spread: Buy a put. Then, sell a put with a higher strike price than the purchased put.

All debit spreads maximize your gains and losses. Investors buying options need the stock’s price to stay within a certain range to maximize their profits. If the stock runs off in either direction, the trader will not realize a profit. A trader can initiate a bullish call debit spread by purchasing a call option with an $80 strike price and selling a call with an $85 strike price. Selling the call at a higher strike price minimizes the maximum loss. If the total premium comes to $2 after factoring in the sold call, the trader needs the stock to reach $82 to break even. Any price between $82 and $85 represents additional profit. Any gains above $85 get canceled out between the long call and the sold call.  

3. Long ATM Put Vertical

Long at-the-money (ATM) puts give traders more time to realize the gains from their position. However, a lack of volatility will hurt the contract’s value. Shorting a put of the same underlying asset that has the same expiration date can act as a hedge for a long ATM put vertical. A trader may buy an at-the-money put with a $70 strike price for a $3 premium. Feeling nervous about market volatility but still liking the position, the trader can sell a put with a $60 strike price and receive a $1 premium. The net cost is only a $2 premium, meaning the stock only has to reach $68 to break even. However, the trader will not realize additional gains if the stock price falls below $60 per share. 

4. Long At-the-Money Call Vertical

Long ATM call verticals are similar to long ATM put verticals. The position starts when a trader buys a long call that is at the money. The trader proceeds to sell a call with a higher strike price to reduce their total cost for entering the position. Your maximum loss gets reduced, but your gains are capped at the strike price of the sold call.

5. Long Ratio Spreads

Long ratio spreads involve three options contracts. If you initiate a long ratio call spread, you will have to buy two calls and sell one call. The sold call will have a lower strike price than the two calls you purchase. A trader may decide to sell a call with a $40 strike price and buy two calls with $45 strike prices. This strategy limits your losses if the stock’s price decreases. The premium from the $40 call you sold can offset the losses from your long calls with $45 strike prices. 

This strategy also minimizes your losses while opening the door to an unlimited upside. If you only buy one call with a $45 strike price and sell one call with a $40 strike price, your gains are limited. Price movements above $45 per share get canceled out between the two calls. However, buying a second long call gives you an unlimited potential upside on the position. The sold call and long call eventually cancel each other out, leaving the second call option without a hedge.

As for a long ratio put spread, this involves selling one put and then purchasing two puts with lower strike prices. It follows the same concept as a long ratio bull spread.   

6. Long OTM Put Calendar

A long out-of-the-money (OTM) put strategy involves buying a put contract and selling a put contract. Other trading strategies follow this framework, but calendar spreads use different expiration dates. Some traders anticipate low volatility won’t last long. These traders can sell short-term puts to offset theta decay from their long-term puts. Theta references how the passage of time results in options losing their value. Theta decay intensifies as an option gets closer to its expiration date. The short-term put may expire worthless and reduce the long put’s cost basis. 

While this strategy can provide steady cash flow and let investors achieve greater gains, it can backfire if the underlying stock’s price falls below the short put’s strike price. Your gains will then get capped at the short-term put’s strike price. Traders can select strike prices that are further out of the money to reduce their risk.

7. Long OTM Call Calendar

Long OTM call calendar spreads follow the same approach as long OTM put calendar spreads. A trader buys a long call that will expire in a year. The same trader can sell a further out-of-the-money call that expires in a month. The short call will expire sooner and give the trader a premium to offset some of the costs from the long-term call. Those premiums can offset a lack of volatility and increase profits. Assume a trader buys a long call with a $100 strike price that expires in one year and sells a call with a $110 strike price that expires in one month. The long call costs $10, while the short call provides a $1 premium. The net cost is a $9 premium.

If the stock rises to $108 per share in one month, the short call will expire worthless. However, the long call will gain value. To make matters better, the trader will realize a higher premium for selling a $110 call that expires in one month now that the stock price is $108 per share. The trader can sell a further out-of-the-money option at $120 per share to lock in more profits. This pattern can work well for the trader, but if the stock’s price exceeds the short call’s strike price, your gains will get capped at that level. If the call was uncovered, you would have to exercise the long call to have enough shares for the short call’s execution.

Short calls are risky options trading strategies, especially if they are uncovered. While a covered call limits your gains, a short uncovered call has unlimited potential losses. Buying 100 shares before selling a call allows you to place a covered call. If you do not have 100 shares while being short a call, it is an uncovered call. 

8. Long Put Butterfly

A long put butterfly involves four put contracts. A trader simultaneously sells two puts and buys two puts. The sold puts are at the same strike price. One of the long puts has a higher strike price than the sold puts, and the other long put has a lower strike price than the sold puts. All puts have the same expiration date.

The two puts you sell provide a high enough premium to minimize the cost of the two long put positions. This arrangement helps a trader realize maximum profits if a stock’s price stays within a small range. Assume a trader initiates a long put butterfly with the following positions:

• Buy one put with a $50 strike price ($2 premium)
• Sell two puts with $55 strike prices (Receive a $1.50 premium for each = $3 total)
• Buy one put with a $60 strike price (50-cent premium)

This strategy limits your potential gains while minimizing how much you can lose. The trader’s max gain is $50 because of the 50 cent premium. Breakeven prices are $59.50 (60-0.5) and $50.50 (50+0.5). Any price below $50.50 or above $59.50 represents a loss. Long butterflies limit your losses, so you do not lose your entire investment. They are optimal if the stock’s price barely moves.

9. Long Put Ladder

A long put ladder trade requires that you initiate positions in three puts. Traders must buy an in-the-money (ITM) put. The ladder is complete when the trader also sells one out-of-the-money put and one at-the-money put. This strategy offers limited upside and substantial downside. You might face a significant loss if the stock suddenly crashes while you’re using the long put ladder strategy.  In this case, if you have an ITM, it will help balance out one of your short puts. However, the other short put could accumulate losses because of the crash. 

The setup is similar to a long put butterfly, but you do not have a protective put if the stock’s price continues to fall. Your losses are limited if the stock gains bullish momentum. However, you have a higher maximum profit with this strategy because you are not paying an additional premium to protect yourself from price declines. Traders should consider their portfolio goals before entering long put ladders and assess their risk.

10. Short Straddle

A short straddle involves shorting a call and a put. The trader receives premiums from both positions and sees maximum upside if the stock’s price barely budges. This trader’s losses can grow if the stock moves sharply in either direction. A short call can compensate for a short put that becomes unprofitable, but that protection is limited. It doesn’t offer the same safety as spreads, but this is a more rewarding trade than spreads if both options expire worthless. The options in the short straddle usually have the same strike price and expiration date.

Benefits of Low Volatility Options Strategies

In financial markets, investors look for ways to reduce risk and improve returns. One strategy that is gaining popularity is low volatility options. These strategies take advantage of low volatility assets. They help traders generate income and protect capital in unstable market conditions. By focusing on options tied to stable stocks or indices, investors can achieve more consistent performance. They may also benefit from lower premium costs. This overview discusses the main benefits of using low volatility options strategies. It highlights how they can provide better financial stability, lower risk exposure, and a favorable risk-reward profile for all traders, whether they are beginners or experienced.

Reduced Risk Exposure

Low volatility options strategies, such as iron condors, covered calls, and vertical spreads, are designed to minimize price fluctuations. These strategies aim to protect against large market swings, effectively lowering overall portfolio risk. By focusing on smaller, more predictable price movements, investors can avoid the significant losses that often accompany high-risk options trading, making them particularly appealing in uncertain or sideways markets.

Steady Income Generation

Low volatility strategies often include selling options, allowing investors to collect premiums regularly, even in stable or neutral market conditions. For example, covered call strategies enable investors to generate income from their stock holdings by selling call options on their positions. This consistent income stream makes these strategies appealing to income-focused investors who desire predictable returns without relying on major market fluctuations to earn profits.

Capital Preservation

Low volatility strategies have a significant advantage. They focus on preserving capital. These strategies are less aggressive than high-risk options. As a result, they are less prone to sharp and sudden losses. A conservative approach makes them suitable for risk-averse investors. These investors prioritize protecting their initial investment. They still seek opportunities for moderate returns. This focus on capital preservation offers stability, especially in volatile or declining markets.

Risks of Low Volatility Options Strategies

Low volatility options strategies are often seen as safe. They focus on securities with stable price movements and low risk profiles. Investors like these strategies for their promise of consistent but modest returns. They also help to reduce exposure to market downturns. However, low volatility can hide significant risks that could affect investors' portfolios. This introduction will explore these risks. These include the possibility of missed opportunities during bullish markets and limited upside potential. We will also consider the effects of volatility shifts. As we discuss these factors, we will look at how they can cause a gap between expectations and outcomes. This gap may challenge the effectiveness of low volatility options strategies in different market environments.

Limited Profit Potential

Low volatility options strategies have a key drawback. They limit upside potential. Strategies like iron condors, covered calls, and credit spreads cap the profit an investor can make. These strategies can offer consistent returns in stable markets. However, they tend to underperform during major market rallies. Investors could miss significant gains when markets rise sharply. This happens because these strategies are designed to profit only within a narrow price range. As a result, their overall profitability is limited.

Time Decay Risk

Many low volatility options strategies depend on time decay (theta) to make profits. Strategies such as selling options or credit spreads benefit from the gradual reduction of an option’s value as it nears expiration. However, this dependence on time decay carries risks if market conditions change. A spike of volatility or unexpected market movements can diminish the value of these positions quickly, even if prices remained stable before the event. This risk associated with time decay becomes significant during sudden market shifts close to expiration. The strategy can lose profitability rapidly under such circumstances.

Unexpected Volatility Spikes

Low volatility strategies typically perform well during stable market conditions. However, they are at risk during sudden volatility spikes. Market shocks—like geopolitical events or unexpected economic data—can trigger sharp price movements. These movements can surprise low-volatility traders. In strategies such as iron condors or credit spreads, investor protection is limited. Sudden increases of volatility can lead to rapid losses. Since these strategies provide limited downside protection, sharp price changes can result in significant losses. This makes them risky when faced with unexpected volatility.

Profiting from Low Volatility

Common strategies like buying a long call or long put can pay off during volatile markets. But the market isn’t always volatile and can reward traders who know about low-volatility opportunities. You don’t have to sit on the sidelines if you believe markets won’t move much in the coming days, weeks and months.

Frequently Asked Questions