Trading Options Very Profitably During a High Volatility Environment

A Quick and Concise Guide with Examples

If you only read one sentence of this tutorial, let it be this: 80% of all options expire worthless. Intuitively then, one would never want to buy options unless they were either mispriced or as a hedge. The price of a call or put option is based on 1) volatility, 2) time value (until expiration) and 3) event risk. If a company is reporting earnings, of course, the options market will price in (higher premiums) the potential outcomes. If economic data is due Wednesday (CPI this week), of course, options will be priced for the potential outcomes via higher premiums. In fact, the best way to think about options is that there is no free money as they will price in the potential outcomes (volatility, time value and event risk) excluding the occasional fat tail or black swan event. In fact, if fat tail events were priced in regularly, selling volatility would be even more profitable. Could you have made a timely put purchase on the Friday before the Monday flash crash and it was grossly mispriced? YES! For every John Paulson, a once in a hundred-year flood lottery winner, there are far more investors who are donating their options bets to the market gods via 80% expire worthless.