With the tumultuous swings in Apple (NASDAQ:AAPL) of late, many would-be traders probably are opting for the safety of the sidelines until the dust settles.
Admittedly, picking the right direction when a stock is in the throes of a massive correction can be downright difficult, even for the nimblest of traders. And yet, in the options market, volatility often spells opportunity.
Let’s take a look at a few volatility measures and see how you can profit from it.
Click to Enlarge One of the most popular measurements of stock volatility is called historical volatility (HV). The accompanying chart of AAPL shows a 20-day reading of HV over the past two years.
Notice how the reading has oscillated in a consistent range between 15 and 45. Not surprisingly, the current selling deluge has lifted Apple’s HV to the upper end of its two-year range. If history is any indication, volatility should begin to taper off and head lower from here.
Click to Enlarge Along with a rise in stock volatility, option premiums — as measured by the CBOE Apple VIX (CBOE:VXAPL) — have been on the rise as well. The recent surge in demand for AAPL options lifted VXAPL to levels not seen since just before the company’s last earnings announcement in October.
The expectation for lower stock volatility coupled with rich option premiums sets up a perfect scenario for selling iron condors.
The iron condor consists of simultaneously selling an out-of-the-money bear call spread with an out-of-the-money bull put spread in the same expiration month. Rather than a bet on stock direction, it’s more of a bet on volatility — specifically, that the stock will move less than the options are currently pricing in.
Traders could enter a February iron condor by selling a Feb 650-660 call spread for $1 and a Feb 430-420 put spread for 90 cents. The net credit for the iron condor is $1.90, which represents the max reward, and will be captured provided AAPL remains between $650 and $430 by Feb expiration.
The max risk comes out to $8.10 and will be incurred if AAPL rises above $660 or falls below $420 by Feb expiration.
Should AAPL volatility fall from its lofty heights and the stock settle into some type of trading range, the iron condor will begin to rack up profits.
As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.