How to profit in this volatile market - Peter Cohan

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How to profit in this volatile market
Oct 20, 2008 02:30 PM UTC

Peter Cohan

Return	Risk
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Symbol	Sentiment	Start	Return	Closed
GS		10/20/08	-18.12%	--
VIX	n/a

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Filed under: Define investing, Goldman Sachs Group (GS), DJIA, Stocks to Buy

The airwaves are full of talk about volatility. But what does volatility mean? It refers to wide up and down swings in the market -- for instance, last Thursday the Dow swung 759 points from its low point to its close. At 11:10 AM it traded as low as 8220 but it closed at 8979. A measure of how big investors think the swings will be is the Volatility Index (VIX) which closed Friday at a record 70.33.

If you believe that the VIX is likely to remain high or get even higher, there is a way to profit from the volatility. That's by creating a trade called a straddle. Before getting into the details of a straddle, here are its payoffs:

The most you can lose is the price you paid for the calls and puts -- called the net debit;

There is no limit to how much you can gain;

The trade breaks even if the stock falls to the strike price minus net debit; and

The trade also breaks even if the stock price rises to the strike price plus the net debit.

So how does a straddle work?

Continue reading How to profit in this volatile market

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