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Taking advantage of volatility with options
The long strangle is a strategy designed to profit when you expect a big move.
- Fidelity Active Investor
- – 09/28/2020
If you expect a stock to become more volatile, the long strangle is an options strategy that aims to potentially profit off sharp up or down price moves.
What is a strangle?
The more volatile a stock (e.g., the larger the expected price swing), the greater the probability the stock may make a strong move in either direction. Like the similar straddle options strategy, a strangle can be used to exploit volatility in the market.
In a long strangle, you buy both a call and a put for the same underlying stock and expiration date, with different exercise prices for each option. The key difference between the strangle and the straddle is that, in the strangle, the exercise prices are different. In a straddle, the exercise prices are the same and normally established “at the money.”
One reason behind choosing different exercise prices for the strangle is that you may believe there is a greater chance of the stock moving in one particular direction, so you may not want to pay as much for the other side of the position. That is, you still believe the stock is going to move sharply, but think there is a slightly greater chance that it will move in one direction. As a result, you will typically pay a substantially lower net debit than you would by buying 2 at-the-money contracts for the straddle strategy.
For example, if you think the underlying stock has a greater chance of moving sharply higher, you might want to choose a less expensive put option with a lower exercise price than the call you want to purchase. The purchased put will still enable you to profit from a move to the downside, but it will have to move further in that direction.
A note about implied volatility
The downside to this is that with less risk on the table, the probability of success may be lower. You could need a much bigger move to exceed the break-evens with this strategy.
Here are a few key concepts to know about long strangles:
- If the underlying stock goes up, then the value of the call option generally increases while the value of the put option decreases.
- Conversely, if the underlying stock goes down, the put option generally increases and the call option decreases.
- If the implied volatility (IV) of the option contracts increases, the values should also increase.
- If the IV of the option contracts decreases, the values should decrease. This can make your trade less profitable, or potentially unprofitable, even if there is a big move in the underlying stock.
- If the underlying stock remains unchanged, both options will most likely expire worthless, and the loss on the position will be the cost of purchasing the options.
Because you are the holder of both the call and the put, time decay hurts the value of your option contracts with each passing day. This is the rate of change in the value of an option as time to expiration decreases. You may need the stock to move quickly when utilizing this strategy. While it is possible to lose on both legs (or, more rarely, make money on both legs), the goal is to produce enough profit from one of the options that increases in value so it covers the cost of buying both options and leaves you with a net gain.
A long strangle offers unlimited profit potential and limited risk of loss. Like the straddle, if the underlying stock moves a lot in either direction before the expiration date, you can make a profit. However, if the stock is flat (trades in a very tight range) or trades within the break-even range, you may lose all or part of your initial investment.
While higher volatility may increase the probability of a favorable move for a long strangle position, it may also increase the total cost of executing such a trade. If the options contracts are trading at high IV levels, then the premium will be adjusted higher to reflect the higher expected probability of a significant move in the underlying stock. Therefore, if the IV of the options you are considering has already spiked, it may be too late to establish the strategy without overpaying for the contracts.
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In this situation, you may want to consider a short strangle which gives you the opportunity to effectively “sell the volatility” in the options and potentially profit on any inflated premiums.
Implied volatility rises and falls, impacting the value and price of options.
The short strangle is a strategy designed to profit when volatility is expected to decrease. It involves selling a call and put option with the same expiration date but different exercise prices.
The short strangle is also a non-directional strategy and would be used when you expect that the underlying stock will not move much at all, even though there are high expectations of volatility in the market. As a writer of these contracts, you are hoping that implied volatility will decrease, and you will be able to close the contracts at a lower price. With the short strangle, you are taking in up-front income (the premium received from selling the options) but are exposed to potentially unlimited losses and higher margin requirements.
Long strangle example
Strangle versus straddle
In comparison, a straddle might be constructed by purchasing the October 40 call for $3.25 and buying the October 40 put for $2.50 at a total cost of $575. This is $150 more than the strangle cost in our example. Note that the stock would have to decline by a larger amount for the strangle position, compared with the straddle, resulting in a lower probability of a profitable trade.
This is the tradeoff for paying $150 less for the strangle, given the expectation that there is a greater likelihood for the stock to make a sharp move to the upside. Alternatively, the stock does not need to rise or fall as much, compared with the straddle, to breakeven.
Assume that in August, you forecast that XYZ Company—then trading at $40.75 a share—will move sharply after its earnings report the following month, and that you believe there is a slightly greater chance of a move to the upside. Due to this expectation, you believe that a strangle might be an ideal strategy to profit from the forecasted volatility.
To construct a strangle, you might buy an XYZ October 42 call for $2.25, paying $225 ($2.25 x 100). We multiply by 100 because each options contract typically controls 100 shares of the underlying stock. At the same time, you buy an XYZ October 38 put for $2.00, paying $200 ($2.00 x 100). Your total cost, or debit, for this trade is $425 ($225 + $200), plus commissions. 1
The maximum possible gain is theoretically unlimited because the call option has no ceiling: The underlying stock could continue to rise indefinitely. The maximum risk, or the most you could lose on the strangle, is the initial debit paid, which in our example is $425. This would occur if the underlying stock doesn’t move much during the life of the contracts.
The profit/loss options calculator can help you set up a strangle trade.
In this example, the cost of the strangle (in terms of the total price for each contract) is $4.25 ($2.25 + $2.00). Break-even in the event that the stock rises is $46.25 ($42.00 + $4.25), while break-even if the stock falls is $33.75 ($38.00 – $4.25). With this information, you know that XYZ must rise above $46.25 or fall below $33.75 before expiration to potentially be profitable.
How to manage a successful trade
Assume XYZ releases a very positive earnings report. As a result, XYZ rises to $48.30 a share before the expiration date. Because XYZ rose above the $46.25 break-even price, our October 42 call option is profitable. Let’s assume it is worth $6.40. Conversely, our October put option has almost no value; let’s say it is worth $0.05.
Before expiration, you might choose to close both legs of the trade. In the above example, you could simultaneously sell to close the call for $6.40, and sell to close the put for $0.05, for proceeds of $645 ([$6.40 + $0.05] x 100). Your total profit would be $220 (the gain of $645 less your initial investment of $425), minus any commission costs.
Another option you have before expiration is to close out the in-the-money call for $6.40, and leave the put open. Your proceeds will be $640 ($6.40 per share.) You lose out on $0.05 per share, or $5.00 (100 x $0.05) in sales proceeds, but you leave it open for the opportunity that the stock will go down before expiration and allow you to close it out at a higher premium.
Now, consider a scenario where instead of a positive earnings report, XYZ’s quarterly profits plunged and the stock falls to $32 before expiration.
Because XYZ fell below the $33.75 break-even price, the October 38 put option might be worth $7.25. Conversely, the October 42 call option could be worth just $0.10. Before expiration, you might choose to close both legs of the trade by simultaneously selling to close the put for $725 ($7.25 x 100) as well as the call for $10 ($0.10 x 100). The gain on the trade is $735 ($725 + $10), and the total profit is $310 (the $735 gain less the $425 cost to enter the trade), minus commissions.
Another option may be to sell the put and monitor the call for any profit opportunity in case the market rallies up until expiration.
How to manage a losing trade
The risk of the long strangle is that the underlying asset doesn’t move at all. Assume XYZ rises to $41 a few weeks before the expiration date. Although the underlying stock went up, it did not rise above the $46.25 break-even price. More than likely, both options will have deteriorated in value. You can either sell to close both the call and put for a loss to manage your risk, or you can wait longer and hope for a turnaround.
When considering whether to close out a losing position or leave it open, an important question to ask yourself is: “Would I open this trade today?” If the answer is no, you may want to close the trade and limit your losses.
Let’s assume that with just a week left until expiration, the XYZ October 42 call is worth $1.35, and the XYZ October 38 put is worth $0.10. Since XYZ didn’t perform as expected, you might decide to cut your losses and close both legs of the option for $145 ([$1.35 + $0.10] x 100). Your loss for this trade would be $280 (the $145 gain, minus the $425 cost of entering into the strangle), plus commissions. You might also consider selling the call that still has value, and monitor the put for appreciation in value in the event of a market decline.
The risk of waiting until expiration is the possibility of losing your entire initial $425 investment. You might also consider rolling the position out to a further month if you think there may still be an upcoming spike in volatility.
There are cases when it can be preferential to close a trade early. As mentioned, time decay and implied volatility are important factors in deciding when to close a trade. Time decay could lead traders to choose not to hold strangles to expiration, and they may also consider closing the trade if implied volatility has risen substantially and the option prices are higher than their purchase price. Instead, they might take their profits (or losses) in advance of expiration. Greeks can help you evaluate these types of factors. 2
The strangle can be a useful variation of the straddle strategy for those stocks you think will make a big move and you think there’s a greater chance of it moving in a certain direction.
Next steps to consider
Get new options ideas and up-to-the-minute data on options.
Trading CFDs in Volatile Market Conditions
Volatile market conditions are the order of the day and CFD traders need to adjust. Nick Sudbury goes to defcon three.
Anyone who follows the markets will be all too aware of the recent upsurge in volatility. One way that this has manifested itself is in a big increase in the typical daily trading ranges. Throughout August for example it was perfectly normal for the FTSE and the Dow to move by well over 100 points during the day.
To put this into perspective, the VIX – an index that uses options to measure the implied volatility of the S&P 500 – recently leapt up to 30. This can be interpreted as meaning that the market is expecting the S&P to end up in a year’s time somewhere within the range of +/- 30% of its current level. Broadly speaking this is equivalent to a daily range of +/- 2%. During the first part of the summer the VIX had been trading at around 10, which amounted to an expected daily range of just +/- 0.6%.
Salim Sebbata, senior director, UK retail at E*TRADE, says that when traders see wild swings in the market, the first thing they should do is review their leverage. ‘If they determine that they can sleep at night, then they are comfortable with the amount of risk they are exposed to. Volatility calls into question how much risk someone is willing to carry, and the rather unscientific sleep factor is a good barometer of risk tolerance.’
Adjusting for the extra volatility
Higher volatility creates both risk and opportunity. It is important, however, for CFD traders to adjust their approach. Those that do this may be able to exploit the larger price movements, while those that don’t will run the risk of their positions being repeatedly stopped out by the heightened market noise.
Mike Estrey, head of research at an advisory trading firm, says it has taken into account the extra market volatility and adjusted the recommendations of its advisory CFD service accordingly. ‘We have widened the stops and reduced the position sizes. The overall effect is to reduce the chance of getting whip-sawed out of a position, while keeping the same level of risk, namely the same possible loss.’
The second precaution that the advisory brokerage has taken is to make sure its recommendations are carefully balanced on longs and shorts within each of the major markets. This strategy has the benefit of making the overall portfolio market-neutral so that the return is not dictated by the direction of the intraday index movement.
Being market-neutral eliminates an important source of risk but it is not the same as a hedge. The reason for doing it is that the performance of the resulting long short portfolio will be driven by the stock-specific element of the returns. This means that, if the short positions fall in value relative to the long positions, then the investor will make money. However, if the shorts gain relative to the longs then the portfolio will return a loss.
Tim Hughes, head of sales trading at IG Index, says that sizeable market-neutral positions would need to be actively managed to avoid any inadvertent exposures. ‘If the market goes against a long position, the size of the resulting exposure falls, whereas if the price rises against a short, the exposure and the resulting risk would both increase. Given the extent of the recent price movements, it is important to manage the trades to ensure the longs have the same monetary exposure as the shorts, otherwise the portfolio would no longer be market-neutral.’
Hedging investment portfolios
A long-term investor who has built up a substantial share portfolio can protect it during times of market weakness by using index CFDs. These offer a flexible way to hedge the exposure and so avoid the risk of heavy losses without incurring the costs and potential tax consequences of selling the underlying holdings. The idea is that any loss on the portfolio would be broadly compensated for by the gain on the CFDs.
Take the example of an investor with £100,000 in a wide range of blue-chip UK equities. By shorting the FTSE 100 index CFD it is possible to engage a broad hedge against the value of the portfolio falling, says Martin Slaney, head of Spread Betting at GFT Global Markets. ‘If the December FTSE is quoted at 6,100 to 6,104, selling £16 a point [16 CFDs] at 6,100 equates to a consideration of £97,600. If the index then fell 100 points, the investor would be able to buy back the FTSE contract at 6,000. The CFD trade would have made £1,600 profit, which is approximately what the portfolio would have lost over the same market move,’ he explains.
Index CFDs are priced from the associated futures contract with the provider adding an extra spread to the underlying quote. At GFT for example the cost of the FTSE 100 CFDs is four points. The typical margin requirement is around 4%, which in this case would amount to £4,000, although many investors prefer to hedge only a proportion of the portfolio.
Slaney says it’s often difficult deciding on the exact timing of when one should engage such a hedge-type trade. ‘One strategy adopted by some of GFT’s customers, which helps remove the emotions often attached to such a decision is to use a trailing stop entry order. A sell order left to trail the FTSE no more than, say, 100 points below the current price will follow the market to the upside but will only be filled as a trade when the market suffers a major drop down. This misses the initial move but protects against any further falls.’
Exploiting the volatility
Estrey says the extreme volatility has created a number of opportunities. ‘One or two of the defensives, such as BT (BT.A), fell too far, as did some of the mining stocks. A long-term investor could pick up some real bargains. The question for leveraged CFD traders is: are they are prepared to risk being stopped out a few times as the shares fall further before they can capitalise on the expected recovery?’
One interesting example that Sebbata noticed was how large-cap technology stocks in the US were more resilient than financial services stocks. ‘Some people have been playing this divergence [using a pairs trade]. Direct market access gives traders quicker executions that might cost a little more than quote-driven CFDs, but in many instances the potential upside makes up for the additional cost,’ he says.
An important pattern that has emerged in recent weeks is the trend for the Dow to experience large reversals late in the session. ‘Quite often we have seen the Dow trading significantly higher or lower two-thirds of the way through the day, only for it to experience a reversal near the close. At IG Markets we call this the eighto’clock bounce,’ says Hughes.
An hourly chart of the Dow reveals significant late reversals took place on 17, 18, 20 and 25 July and on 13, 15 and 16 August. The magnitude of these moves is such that CFD investors with leveraged positions need to decide how they are going to handle them.
Someone with a profitable position opened earlier in the day, who wanted to try and keep the exposure overnight, would need to actively manage the position of the stop loss. By successively moving this up behind the price increases on a long position, or down following the falls on a short, the investor would be able to lock in the majority of the gain. This would allow an attempt to maintain the position while guarding against a late reversal turning the profit into a loss.
It is also possible to trade the reversal itself. An investor in the UK could look at the Dow at around 7pm and decide at that point whether the trade was on. If so, an automatic order could be left to open a position so as to capture the anticipated move. For example, if the Dow was down on the day, an investor who anticipated a late reversal could enter an order to buy should the price recover to hit a specified higher level. A good-untilclose order would automatically expire if the index failed to reverse sufficiently to trigger the trade.
James Hughes, market analyst at CMC Markets, says traders have to adjust their approaches for the volatile conditions. ‘When markets are chopping around a lot it makes sense to use support and resistance levels. What makes these so good is that they work in both the short term and the long term.’
When looking for key support and resistance levels, traders will tend to start with the longer term chart. They will then shorten the time interval and focus on the more immediate data to try and refine their entry and exit points.
According to CMC’s Hughes, the two big support levels on the Dow are 13,200 and 13,000. Both were temporarily breached, with the index closing below them on the 15 and 16 August, before the buyers kicked in and helped push it up over 400 points. ‘The most important level of support is just below 6,000 on the FTSE. This goes back to October, and a break below 5,960-5,980 could potentially herald a large fall,’ he says.
The FTSE index broke above the psychologically important 6,000 level in October 2006. This area of resistance was subsequently established as the key level of support and, when it was tested in early December and early March, it held firm on both occasions. The FTSE finally breached and closed below the 6,000 mark on 16 August, although this quickly encouraged the buyers back into the market and helped the index to add over 300 points.
Raj Chandel’s Blog
5 ways to Exploit LFi Vulnerability
The main aim of writing this article is to share the idea of making an attack on a web server using various techniques when the server is suffering from file inclusion vulnerability. As we all are aware of LFI vulnerability which allows the user to include a file through URL in the browser. In this article, I have used two different platform bWAPP and DVWA which contains file inclusion vulnerability and through which I have performed LFI attack in FOUR different ways.
Basic Local file inclusion
Open target IP in the browser and login inside BWAPP as a bee: bug now chooses the bug remote & local file Inclusion then click on the hack.
Here the requested web page which suffering from RFI & LFI Vulnerability gets open. Where you will find a comment to select a language from the given drop-down list, and when you click on go button the selected language file gets included in URL. To perform basic attacks manipulate
In basic LFI attack we can directly read the content of a file from its directories using (../) or simply (/), now if you will notice the given below screenshot you will find that I have access the password file when the above URL is executed in the browser.
In some scenario, the above basic local file inclusion attack may not work due to the high-security level. From the below image you can observe now that I got to fail to read the password file when executing the same path in URL. So when we face such kind of problem then go for NULL BYTE attack.
Now turn on burp suite to capture the browser request then select the proxy tab and start intercept. Do not forget to set browser proxy while making use of burp suite
Now inside burp suite send the intercepted data into the repeater.
Inside repeater, you can do an analysis of sent request and response generated by it. From the screenshot, it will be clear that /etc/passwd is not working and I am not able to read the password file.
From the following screenshot, you can see I had forward the request by adding null character (%00) at the end of directory /etc/passwd%00 and click on go tab. Then on the right sight of the window, the password file gets open as a response.
Now there is another way to exploit LFI when the security level is high and you are unable to view the PHP file content, and then use the following PHP function.
How to Measure Volatility
Measuring Volatility: Talking points
- Volatility is the measurement of price variations over a specified period of time.
- Traders can approach low-volatility markets with two different approaches.
- We discuss the Average True Range indicator as a measurement of volatility.
Technical Analysis can bring a significant amount of value to a trader.
While no indicator or set of indicators will perfectly predict the future, traders can use historical price movements to get an idea for what may happen in the future.
A key component of this type of probabilistic approach is the ability to see the ‘big picture,’ or the general condition of the market being traded. We discussed market conditions in the article The Guiding Hand of Price Action; and in the piece we enclosed a few tips for traders to qualify the observed condition in an effort to more properly select the strategy and approach for trading that specific condition.
In this article, we’re going to take the discussion a step further by focusing on one of the primary factors of importance in determining market conditions: Volatility.
Volatility is the measurement of price variations: Large price movements/changes are indicative of high volatility while smaller price movements are low volatility.
As traders, price movements are what allow for profit. Larger price variations mean more potential for profit as there is simply more opportunity available with these bigger movements. But is this necessarily a good thing?
The Dangers of Volatility
The allure of high-volatility conditions can be obvious: Just as we said above, higher levels of volatility mean larger price movements; and larger price movements mean more opportunity.
But traders need to see the other side of this coin: Higher levels of volatility also mean that price movements are even less predictable. Reversals can be more aggressive, and if a trader finds themselves on the wrong side of the move, the potential loss can be even higher in a high-volatility environment as the increased activity can entail larger price movements against the trader as well as in their favor.
For many traders, especially new ones, higher levels of volatility can present significantly more risk than benefit.
The reason for this is The Number One Mistake that Forex Traders Make; and the fact that higher levels of volatility expose these traders to these risks even more than low-volatility.
So before we go into measuring or trading volatility, please know that risk management is a necessity when trading in these higher-volatility environments. Failure to observe the risks of such environments can be a quick way to face a dreaded margin call.
Average True Range
The Average True Range indicator stands above most others when it comes to the measurement of volatility. ATR was created by J. Welles Wilder (the same gentlemen that created RSI, Parabolic SAR, and the ADX indicator), and is designed to measure the True Range over a specified period of time.
True Range is specified as the greater of:
- High of the current period less the low of the current period
- The high of the current period less the previous period’s closing value
- The low of the current period less the previous period’s closing value
Because we’re just trying to measure volatility, absolute values are used in the above computations to determine the ‘true range.’ So the largest of the above three numbers is the ‘true range,’ regardless of whether the value was negative or not.
Once these values are computed, they can be averaged over a period of time to smooth out the near-term fluctuations (14 periods is common). The result is Average True Range.
In the chart below, we’ve added ATR to illustrate how the indicator will register larger values as the range of price movements increases:
prepared by James Stanley
How to Use ATR
After traders have learned to measure volatility, they can then look to integrate the ATR indicator into their approaches in one of two ways.
- As a volatility filter to determine which strategy or approach to employ
- To measure risk (stop distance) when initiating trading positions
Using ATR as a Volatility Filter
Just as we had seen in our range-trading article, traders can approach low-volatility environments with two different approaches.
Simply, traders can look for the low-volatility environment to continue, or they can look for it to change. Meaning, traders can approach low-volatility by trading the range (continuation of low-volatility), or they can look to trade the breakout (increase in volatility).
The difference between the two conditions is huge; as range-traders are looking to sell resistance and buy support while breakout traders are looking to do the exact opposite.
Further, range-traders have the luxury of well-defined support and resistance for stop placement; while breakout traders do not. And while breakouts can potentially lead to huge moves, the probability of success is significantly lower. This means that false breakouts can be abundant, and trading the breakout often requires more aggressive risk-reward ratios (to offset the lower probability of success).
Using ATR for Risk Management
One of the primary struggles for new traders is learning where to place the protective stop when initiating new positions. ATR can help with this goal.
Because ATR is based on price movements in the market, the indicator will grow along with volatility. This enables the trader to use wider stops in more volatile markets, or tighter stops in lower-volatility environments.
The ATR indicator is displayed in the same price format as the currency pair. So, a value of ‘.00458’ on EUR/USD would denote 45.8 pips. Alternatively, a reading of ‘.455’ on USDJPY would denote 45.5 pips. As volatility increases or decreases, these statistics will increase or decrease as well.
Traders can use this to their advantage by placing stops based on the value of ATR. If you’d like more information on this method, we discuss the premise at length in the article, Managing Risk wi t h ATR .
Frequently Asked Questions (FAQS)
What is the best tool for risk management?
While there is no ‘best’ tool for managing risk, at Dailyfx we studied millions of live trades in our traits of successful traders guide and found that a positive risk-reward ratio led to traders being more successful. We also recommend only risking 1% of account capital per trade and 5% of capital on all open trades. Using excessive amounts of leverage often leads to traders ‘blowing’ their accounts.
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