Volatility Examples
With IG Markets, you can buy volatility (when you think there will be movement) or sell volatility (when you think the market will be flat) using either binaries or options.
Buying and selling volatility
If you think there will be a big move in a particular market, you can buy volatility, using either binaries or options. If you think a particular market is going to be flat for a certain period, you can sell volatility, again, using either binaries or options. The examples below illustrate each of these strategies.
Buying volatility using binaries
You decide the FTSE® 100 will have a big shift after the US non-farm payroll figures are announced, so you decide to buy £10 per point at the offer price of both the 'FTSE® to finish up more than 50 points' Binary and also the 'FTSE® to finish down more than 50 points' Binary. The current IG Markets prices for these positions are as follows:
- 8-11 for the 'FTSE® to finish up by more than 50 points' Binary
- 6-9 for the 'FTSE® to finish down by more than 50 points' Binary
As you are buying, you pay the offer price in each instance for a total price of 20 (11+9) points to back a 50-point FTSE® move in either direction.
Calculating your profit/loss
All Binaries will finish at 100 if the statement is true, and at zero if false. From this you subtract your stake (20 points, in this case) to calculate your profit/loss.
In our scenario, let's say payroll figures are significantly better than expected and the FTSE® climbs suddenly as a result to close 74 points higher. So, you were proved right and the Binary settles at 100.
| Calculation | |
|---|---|
| Settlement | 100 |
| Stake | 20 |
| Difference | 80 |
| Profit: 80 x £10 = £800 | |
Selling volatility using binaries
You can use binaries to benefit from markets when you expect there will be no movement at all.
Let's say the FTSE® is currently trading at 5360 and the market is quiet. You don't believe the market will move any higher than its current level, so you sell £10 per point of the daily 'FTSE® to touch 5400' contract at the current price of 40. By using a OneTouch binary in this way you have sold volatility on the FTSE®. You will make £400 (40 x £10) if the FTSE® fails to hit 5400 during the rest of the day, and you will lose £600 ((100-40) x £10) if you are wrong and the FTSE® moves higher and hits 5400 before the close.
Calculating your profit/loss
In our scenario, let's say the FTSE® does in fact rise to above 5400 during the afternoon. This means your binary will settle at 100 and you will make a loss on the position.
| Calculation | |
|---|---|
| Settlement | 100 |
| Open level | 40 |
| Difference | 60 |
| Loss: 60 x £10 (stake) = £600 | |
Buying volatility using options
You believe there will be a big move on the FTSE® (away from its current level of 5300) so you decide to buy 'daily FTSE® options' to take advantage of this. You buy:
- £10 of the 5300 Call at 14, and
- £10 of the 5300 Put at 16
You have bought a 'daily 5300 FTSE® straddle'.
Because you have paid a total of 30 (14+16), you need the FTSE® to move 30 points away from 5300 in either direction (5270 or 5330) to break even. So, for every point that the FTSE® moves beyond 5270 or 5330 you make £10.
In our scenario, let's say positive non-farm payrolls figures come in, pushing the FTSE® higher to finish at 5372. You make 42 points overall.
| Calculation | |
|---|---|
| Closing level | 5372 |
| Opening level | (5300) |
| Premium | (30) |
| Difference | 42 |
| Profit: 42 x £10 = £420 | |
In this example, your worst-case scenario would be the FTSE® not moving at all after the payrolls announcement and finishing at 5300. If this happened you would lose £300 (£30 (your premium) x 10 (your stake)). This £300 represents your total risk on this position.
In this above example you are 'buying volatility' on the FTSE®, rather than simply 'buying' or 'selling' the FTSE®, which you would do with a more traditional 'Daily FTSE®' trade.
Selling volatility using options
You believe it is very unlikely that GBP/USD will move more than 102 points before the close and so choose to sell both the daily GBP/USD 16600 Call and the 16600 Put. You sell:
- £10 of the 16600 Call at 52, and
- £10 of the 16600 Put at 50
You have a sold a 'daily 16600 GBP/USD straddle'.
Because you have sold a total of 102 (52 + 50), you need GBP/USD to close within 102 points of 16600 to finish in profit. For every point over this range - under 16498 (16600 - 102) or over 16702 (16600 + 102) - you will lose £10 per point.
In our scenario, let's say disappointing UK growth figures are announced, contrary to what was expected, dragging sterling down against the dollar, with the pair closing the day at 16485.
| Calculation | |
|---|---|
| Closing level | 16485 |
| Opening level | (16600) |
| Movement | 115 |
| ... | |
| Premium | 102 |
| Movement | (115) |
| Difference | -13 |
| Loss: 13 x £10 = £130 | |
In this example you know your best-case scenario - if GBP/USD does not move at all and closes at exactly 16600, with the result that both options will finish worthless, you will make £1020 (102 (your premium) x £10 (your stake)). However, it is important to understand that when selling options your risk is unlimited.
In this example you are 'selling volatility' on GBP/USD, and therefore backing a view that holds there will be relatively little movement in GBP/USD on the day.
