As option traders, we must always be aware of the various factors that affect options. As regular stock traders we only need to focus on direction and trying to get that right. One thing option traders must pay attention to is volatility and what it is doing to options. Simply, we will want to sell "expensive" options and buy "cheap" options.
Now the terms expensive and cheap are relative and don't mean much if we don't say what they are relative to.Click to enlargeIn this case we will say options are cheap when volatility is lower than normal and options are expensive when volatility is higher than normal. Google (NASDAQ:GOOG) has been on a nice little run up as of late. They had a solid earnings release and have been riding the wave up since.
Looking at the volatility, we see it hovering around the lower 20s. We can also see the average volatility run around the higher 20s.
So what do we do here? Buy calls? Buy puts? Something else? The one thing we know is that volatility is low. We still have no idea if the price is going to go up or down. Therefore, we want to avoid the puts and calls and focus on volatility plays. There are several volatility plays, but the one I like here is the long straddle.
The long straddle is used when you expect a large movement but unsure of which direction. It is also a great play to use when we are looking for volatility to expand.
The trade we are looking at here is the September GOOG 640 Straddle.
Looks like we have a 35 debit pushing our breakeven spots at 605/675. That is a move of 5% in either direction, which is something Google should achieve in the next month. Again, we are not banking on the move as much as the uptick in volatility. We get a big move, say +10% in volatility, we can go ahead and close out the trade.
Still not sure about the trade? Don't take a large position. Stick with 1 lot to get a feel for how it works.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GOOG over the next 72 hours.