Neutral Trading Strategies Or Non-Directional Trading Strategies : High Or Low Volatility Option Strategies

A trader uses neutral trading strategies when there are uncertainties regarding price of the underlying security, that is, a prediction cannot be made regarding the direction of the market. Rather, the trader makes trades based on the volatility assessment of the underlying security. Hence, neutral options trading strategies are also known as non-directional trading strategies.

For example, if a trader expects an upcoming earnings announcement but is not sure whether the company will exceed analyst expectations and surprise to the upside or disappoint. The trader may look at the company’s record of earnings. The trader may even go one step further and use fundamental analysis to determine what could possibly happen to the company. And he may come to the conclusion that it could go either way when earnings are announced. He then decides to use strategies that will capitalize on high volatility in time to come, making sure not to overpay for the execution of the trade.

What I have just described is the mental thought processes of a trader when determining such a trade. In any case, his strategy is non-directional and neutral.

High volatility options trading strategies

When the price of the underlying security is expected to be highly volatile, a trader can consider using high volatility options trading strategies that profit from large swings, upwards or downwards, in underlying security price. These strategies include:

  • Long strangle strategy
  • Short condors strategy
  • Short butterflies strategy
  • Long straddle strategy

Some factors that cause volatility are earnings announcements, dividend hikes or cuts and/or merger and acquisition events. There are so many factors that can cause volatility that this is really just the tip of the iceberg. Sometimes, when a stock’s price is so terribly undervalued, mean reversion takes place. That is, a once beaten down stock starts to appreciate in price again even in the absence of any news or fundamental catalyst. All these factors and more will cause and increase in volatility. This is one more reason to be well versed in fundamental analysis.

Low volatility options trading strategies

When the price of the underlying security is expected to have little to no volatility, a trader can use low volatility trading strategies. Some of these strategies are:

  • Short strangle strategy
  • Long condors strategy
  • Ratio spreads strategy
  • Short straddle strategy
  • Long butterflies strategy

In a low volatility strategy, the trader would prefer a period of low trading activity, typical of range bound markets. The narrower the range, the higher the chance that the trader will gain a profit from the trade.