Dealing with Market Volatility Spikes

One of the most daunting tasks for the option trader is dealing with a spike in market volatility. The situation is particularly difficult because of option’s leverage and risk. It is further compounded if you are also short volatility and dealing with large price movements. Often panic can set in for the new trader, as the price and volatility keep moving against a position. There are things you can do both in the short-term and longer-term to help protect your position.

First, “stop the bleeding”. By that I mean buy long options or long option verticals to immediately stem the tide that is going against you. If you have a spread type trade on and the price and volatility are running hard one way against you, pick up a long option immediately to at least slow down the damage while you further analyze a more appropriate adjustment to your position. Long options and simple verticals often have less slippage and you can get a quick execution of your trade even in a market that is volatile. At this point you have at least reduced the risk on the bad side of your trade.

Once you have slowed down the damage, we can look at further repairing the trade. Depending on the strategy that you are utilizing this may involve rolling out short verticals to further out strikes, adding to the position with more verticals or spreads or in certain cases exiting to trade altogether. Sometimes exiting the trade and then perhaps starting it again another day when the market has calmed down is also a good plan. Typically look to do two, maybe three adjustments to any option position that is working against you and after that consider closing the position. It is important to have this planned before hand so that you have your possible adjustments in mind and also an exit plan at a max loss point that you previously chosen. Planning ahead is key otherwise fear and emotion can cloud good judgment.

Volatility swings in the market are part of life for the trader. Learn to master these and it will increase the success of your option trading business.