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Trading of expected changes in volatility

Have you thought about the fact that the prices of the financial instruments can go only in two directions? This is huuuuuge advantage and you have to learn hot to exploit it. Volatility is cyclical and sometimes it is easy know that significant change could be expected. Such cases are releases of major economic news or other important events such as central banks meetings. Years ago, you could just place a buy stop order above the current market price and a sell stop order below it. Orders were filled with no slippage and the price moves were large enough to let you make good profit. Now times are different. Slippage could be huge and the price moves are small and volatile. Sometimes both orders were filled and both positions were losing. HFTs changed significantly the rules of the game and if we want to make money, we have to trade smart.

Options provide good opportunities to profit from expected changes in volatility. If you know well the market, you can make profits in both directions. Let me show you how you can do it with an example from the ECB meeting in December 2013. EUR/USD was showing strength and the path with less resistance was up. Mario Draghi had to be extremely dovish to cause a Euro sell off. I didn't expect huge price move and binary options were better than plain vanilla. My choice was a strangle structured by a sale of ladder with 1.3510 strike and purchase of a ladder with 1.3640 strike. Total cost was 21.9 pips, while maximum profit at expiry was 78.1 pips. Expiry of both options was at the London fix. ECB press conference starts at 1:30 PM (London time) and I chose the nearest expiry to save some time value.

Super Mario started with the usual stuff about inflation, growth and ECB mon pol. EUR/USD dipped 50 pips but there was no follow-through. Price action on 1-minute chart and quote reading were clearly showing that someone is buying. When the market cannot go in one direction, it goes to the opposite. I closed my short 1.3510 ladder at average price of 81. EUR/USD turned higher as the market participants decided that ECB would not apply negative interest rates. I closed 1/3 of my 1.3640 option at 45.6, 1/3 at 75.8, and the last 1/3 at 93.7 (10 minutes before the expiry). Total profit was 68.8 pips. Risk/reward ratio of 1/3 when you can profit form a price move in any direction is pretty good.

Let my tell you why I closed the last part 10 minutes before expiry. EUR/USD was 10 pips above the strike. Maximum price of the ladders is 100. There was a risk of a large sell order for the London fix and I was risking 93.7 pips for only 6.3 more. There was no reason to wait.

Trading is a zero sum game and your profit is a loss for someone else. If you want to make money, you must have an edge. The only edge IMHO is the KNOWLEDGE. The knowledge which financial instrument is best for the current situation. The knowledge to identify when the market sentiment is changing.