Low volatility strategies using options
In recent months, major cryptocurrencies have exhibited their lowest volatility levels in years. A look at the past 2 years of DVOL (Deribit’s 30-day ATM historical implied volatility) showcases this historic low.
While low-volatility markets might seem less attractive for trading, options introduce a new dimension: trading based on volatility. This allows traders to capitalize on expected volatility shifts in addition to price directionality, making certain options strategies especially relevant during calm, low-volatility periods.
Glossary
Options — Financial contracts granting the right, without the obligation, to buy or sell an asset like Ether at a specified price (strike price) by a specific date (expiry date).
At-the-money (ATM) — An option is ATM when its strike price matches the current price of the underlying asset. For instance, if ETH is priced at $1850, an ATM option might have a strike price of $1850.
In-the-money (ITM) — A CALL option is ITM if its strike price is less than the current asset price. Conversely, a PUT option is ITM when its strike price is above the asset’s price.
Out-of-the-money (OTM) — A CALL option is OTM when its strike price exceeds the current asset price. In contrast, a PUT option is OTM if its strike price is below the asset’s current price.
Intrinsic Value — The amount by which an option is ITM. Only ITM options possess intrinsic value, which is the difference between the strike and current prices.
Extrinsic Value — The market value of the implied volatility within an option leading up to its expiry. If an option is ITM, the extrinsic value adds to its intrinsic value. For OTM options, the premium is entirely extrinsic.
Impact of Volatility on Option Pricing
First, let’s examine how volatility affects options trading.
Options are typically priced based on the likelihood that the underlying asset will have intrinsic value when they expire (expiring ITM). The higher this likelihood, the more expensive the option becomes.
Several factors can amplify this probability. For instance, the longer the time to expiry, the greater the chance an option will expire profitably, raising its price. Additionally, there’s a positive correlation between volatility and the likelihood of the option’s profitability. A greater expected movement in the underlying asset increases the chance that significant swings will push the option to expire ITM. It’s crucial to note that traders forecast this volatility, known as Implied Volatility (IV), when setting the option’s price.
Let’s have a look at how IV impacts pricing an option. The following table shows the same instrument but with different IV levels, indicating the impact on the option’s Theoretical Price.
As you can see the price is highly impacted by the Implied Volatility (IV). You might think that 100% IV is actually impossible to achieve, but have a look at the chart at the top of the article and see that DVOL has been over 100% IV many times in the last 2 years.
Low Volatility Strategies
As volatility diminishes, the prices of both CALL and PUT options across all strike prices tend to drop. This drop is due to the reduced likelihood of the options ending ITM. Low volatility environments are often perceived as challenging for option sellers, given the slim and modest premiums. In such scenarios, one might be tempted to go long on volatility by buying options, especially when they seem ‘cheap’ compared to historical standards. However, not all option strategies are created equal. Below, find some strategy ideas tailored for low volatility environments.
Long at-the-money (ATM) CALL debit spread (Bullish 🐂)
Feeling bullish in a low volatility environment? An ATM long CALL debit spread is your go-to strategy!
This strategy entails purchasing an ATM CALL option and selling an OTM CALL with the same expiration date. It’s termed a “debit spread” because you pay a debit, which is the difference between the premium of the long option and the received premium of the short option.
This approach aims to capitalize on a rise in the underlying asset’s price before its expiration. An uptick in implied volatility can also enhance the CALL debit spread, making it particularly attractive in situations where volatility is anticipated to grow.
Payoff
The potential downside of the strategy is equal to the debit paid to enter the spread. Because there is a short option sold to reduce the cost basis, the maximum profit potential is limited to the spread width (higher strike — lower strike) minus the debit paid.
Example
ETH price: $1,845
Sentiment: Bullish
Strategy: CALL debit spread
First leg: LONG 25AUG23 $1850 CALL
- Premium: $34.50 (30% IV)
Second leg: SHORT 25AUG23 $1900 CALL
- Premium: $15.98 (29% IV)
Debit paid: $18.52 (long premium — short premium)
Breakeven: $1868.52 (long strike + debit paid)
Max profit: $31.48 (higher strike — lower strike — debit paid)
Max loss: $18.52 (debit paid)
A CALL debit spread is a great way to scalp in a rangebound market where you think the market will move upside but not much.
Strategy Highlights
Long at-the-money (ATM) PUT debit spread (Bearish 🐻)
Conversely to the CALL debit spread, a PUT debit spread turns the situation completely on its head. With a long PUT debit spread, you are betting on volatility to increase in a bearish environment. In this case, the long debit spread is constructed by buying an ATM PUT option and selling an OTM PUT with the same expiration date, performing at its best in a bearish scenario.
Payoff
The potential loss of the strategy is equal to the debit paid to enter the spread. The maximum profit potential is limited to the spread width (higher strike — lower strike) minus the debit paid.
Example
ETH price: $1,845
Sentiment: Bearish
Strategy: PUT debit spread
First Leg: LONG 25AUG23 $1850 PUT
- Premium: $38.17 (27% IV)
Second Leg: SHORT 25AUG23 $1800 PUT
- Premium: $15.55 (26% IV)
Debit paid: $22.62 (long premium — short premium)
Breakeven: $1827.38 (long strike — debit paid)
Max profit: $27.38 (higher strike — lower strike — debit paid)
Max loss: $22.62 (debit paid)
A PUT Debit spread is a great way to scalp in a rangebound market where you think the market will move downside but not much.
Strategy Highlights
Long Straddle (Neutral 🐻🐂)
Feeling the volatility will increase but don’t have a strong opinion in which direction the market will move? A long straddle is your strategy!
This involves purchasing both an ATM PUT and an ATM CALL with the same strike and expiry. The strategy aims to capitalize on a spike in volatility and a significant shift in the underlying spot price, irrespective of the direction.
Straddles are useful when it’s unclear what direction the underlying price might move in, but a spike in volatility is expected
Payoff
The maximum loss for a long straddle is the combined premiums of the two long positions.
While the profit potential is limitless, a movement in one direction before expiration is necessary for potential profitability. The net profit equals the premium received from closing the position minus the premium initially spent on the strategy.
The break-even point for the trade is the sum of the premium paid (CALL premium + PUT premium) above or below the strike price.
Example
ETH price: $1,845
Sentiment: Neutral
Strategy: Long straddle
First Leg: LONG 25AUG23 $1850 PUT
- Premium: $38.17 (27% IV)
Second Leg: LONG 25AUG23 $1850 CALL
- Premium: $34.50 (30% IV)
Premium paid: $72.67
Breakeven: below $1777.33 or above $1922.67
Max profit: unlimited
Max loss: $72.67
Strategy Highlights
Long Strangle (Neutral 🐻🐂)
Long Strangle is a similar strategy to long straddle with few main differences:
Payoff
The maximum loss on the trade is defined at entry and it’s the sum of the premium to long the PUT and CALL.
The potential for profit is technically unlimited, though a large move in one direction before expiration is required. Compare to straddle the directional and volatility movement required to be profitable is higher, since the price to enter is lower.
Example
ETH price: $1,845
Sentiment: Neutral
Strategy: Long strangle
First Leg: LONG 25AUG23 $1800 PUT
- Premium: $16.94 (29% IV)
Second Leg: LONG 25AUG23 $1900 CALL
- Premium: $18.94 (30% IV)
Premium paid: $35.88
Breakeven: below $1764.12 or above $1918.94
Max profit: unlimited
Max loss: $35.88
Strategy Highlights
Long CALL calendar (Bullish 🐂)
Are you feeling neutral to bearish in the short-term but bullish mid-term? Then a long CALL calendar might be the right strategy for you!
This strategy entails shorting a CALL option while simultaneously going long on another CALL option with the same strike price but a later expiration than the shorted CALL.
The CALL calendar strategy aims to capitalize on minimal price movements and time decay in the short term through the short position while leveraging potential volatility increases and upward price movements in the mid-term with the long position.
Success with this strategy occurs if the price of the underlying asset stays below the short CALL’s strike price in the near term, and then rises, preferably with increased volatility. It’s optimal in scenarios where the underlying price is projected to remain neutral or turn slightly bearish in the short term. This is followed by an anticipated rise in volatility accompanied by a bullish movement after the expiration of the short-term option but before the closure of the longer-dated option.
As the longer-dated options generally cost more, a debit is incurred. This is because the premium for the long CALL surpasses that of the short position.
Call calendars can also be structured around specific events. For instance, if a trader anticipates an event next month that might boost spot/volatility but doesn’t wish to account for the immediate volatility, they could sell the current month’s option and buy the subsequent month’s option.
Payoff
The payoff diagram for a call calendar spread is variable and has many different outcomes depending on when the options trader decides to exit the position.
The maximum profit is realized if the underlying asset price equals the strike price of the short CALL. At this point, the profit is maximized since the long CALL has maximum extrinsic value and the short CALL expires worthless. But overall for this strategy, the max profit is unknown because it depends on the price of the long position which can vary based on the implied volatility.
At the time of the first expiry there are 2 possible outcomes:
- Short CALL expires ITM. In this case, the loss will be the debit paid to enter the position, assuming the long position is closed.
- Short CALL expires OTM. This is the goal of the calendar spread: keep the short expiry OTM. In this case, the short CALL position is worthless. The long CALL still has extrinsic time value remaining. At this point, the position can be exited or can be held with no increased risk.
The maximum loss of a long calendar spread is defined at entry by the debit paid (premium paid for the long-term option — paid received for the short-term option), assuming the long position is closed at the time the short one expires.
Example
ETH price: $1,845
Sentiment: Neutral for the short expiry, bullish for the longer expiry
Strategy: Long CALL calendar
First Leg: SHORT 25AUG23 $1900 CALL
- Premium: $15.98 (29% IV)
Second Leg: LONG 29SEPT23 $1900 CALL
- Premium: $57.96 (30% IV)
Debit paid: $41.98
Breakeven: Unknown
Max profit: Unknown
Max loss: $41.98 (debit paid)
Note that if the trader were to simply buy the 29SEPT23 $1900 CALL expiration, the cost would have been $57.96, but by entering the calendar spread, the cost required to make and hold the position was only $41.98, making the trade one of greater margin and less risk.
Strategy Highlights
Long PUT calendar (Bearish 🐻)
Conversely to the CALL calendar, a PUT calendar flips the trade bias. With the long PUT calendar, it is possible to capitalize when the market is stable in the short term but expected to drop with a volatility increase in the mid-term.
A long put is constructed by shorting a PUT option whilst longing a PUT option with the same strike price but a later expiration.
Put calendars can potentially benefit from an increase in volatility if it increases on a drop in the underlying price.
Payoff
The maximum profit occurs when the price of the underlying for the shorter PUT is higher or equal than the short strike price and the price falls to the longer strike by the longer expiration.
The Maximum potential loss is the debit paid.
Example
ETH price: $1,845
Sentiment: Neutral for the short expiry, bearish for the longer expiry
Strategy: Long PUT calendar
First Leg: SHORT 25AUG23 $1800 PUT
- Premium: $15.55 (26% IV)
Second Leg: LONG 29SEPT23 $1800 PUT
- Premium: $57.96 (30% IV)
Debit paid: $42.41
Breakeven: Unknown
Max profit: Unknown
Max loss: $42.41 (debit paid)
Note that if the trader were to simply buy the 29SEPT23 $1800 PUT expiration, the cost would have been $57.96, but by entering the calendar spread, the cost required to make and hold the position was only $42.41, making the trade one of greater margin and less risk.
Strategy Highlights
What’s Next?
Remember, options trading can be both rewarding and risky. Understanding the intricacies of each strategy is key to making informed decisions and managing your positions effectively. But with a bit of knowledge and a sprinkle of humor, you’ll be navigating the options market and low-volatility environments like a pro in no time!
Trade options with Rysk 👉 https://app.rysk.finance
Happy trading, and may the volatility be ever in your favor!
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