Volatility vs. Risk
Volatility: This refers to the rate at which the prices of an underlying instrument increase or decrease within a particular return environment. Greater the volatility, wider and more frequent are the price swings. It is a measure of size and speed of the movements in the prices of the asset.
Risk: This is actually the real possibility of losing some or all of the investment. It takes different forms; there is such a thing as market risk, which is a danger of prices moving against you with greater velocity than it was before, especially as the market turns more volatile. Of course, this is usually along with a greater-than-average trading volume and unusual sensitivity to any news that causes stronger-than-normal price fluctuations.
Hedging Against Volatility
Precautionary Measures
Stop-Loss Orders: A person can hedge against this kind of volatility by placing stop-loss orders. The orders sell shares for you once prices have fallen to a certain level. That will limit your losses, but it also may lead to taxable events and removes investments from your portfolio.
Protective Put Options: For very long-term investors, it might be more appropriate just to buy protective put options. A put option is an option and not an obligation to sell shares at a given price before the expiry of a contract. For example, you have a stock trading at $100, and you feel you would like to have insurance against a 20% fall, so you buy an $80 strike put option. It puts a floor price, that is, you can sell for $80 even if it drops to $50.
Directly Trading Volatility
Volatility-based Instruments
ETFs and ETNs: Trading of the volatility indices following class can be done with the help of Exchange-Traded Funds or Exchange-Traded Notes. Example – VIX of the Chicago Board Options Exchange is set to measure the expected volatility over a 30-day period concerning the S&P 500 Index. The enhancement with the VIX tracking product comes when the volatility increases and, therefore, makes the value of the product higher as well.
Options Contracts: Similarly, options buying contracts can be another way to play the rising volatility as a means to gain profit. Since the volatility is correlated with the prices of both calls and puts, the cost of that protection will be much higher if market atmospheres are more volatile. Think about buying straddles or strangling. It involves buying a call and a put option with the same underlying security and expiry date. Only in the case of extraordinarily higher or lower prices, this strategy will come out to be beneficial.
Practical Investment Strategies in Turbulent Markets
Operational Tactics
Straddles: A straddle involves buying one call and one put on the same security with the same expiration date. That way, this strategy profits either way the price moves-up or down—in great part, so it would be a strategy apt for very volatile markets.
Strangles: Much like a straddle, a strangle is made by buying a call option and a put option—except the strike prices are more dispersed. This is cheaper than buying a straddle and may be useful when one thinks prices are going to take a large move but have no idea which way they’d go.
Diversification: Helps in the management of risk when one invests in different classes of assets. You will be able to diffuse your investments in several sectors and classes of assets. This will reduce the impact of volatility on a single investment.
Inference: Maximising Your Strategy in Volatile Markets
After all, it really does take a good understanding of the interplay between volatility and risk, complemented by an equally effective amount of hedging and trading techniques applied, to work in harmony with investments to truly maximize the situation during markets where there is much movement. The protective puts, trading on volatility indexes, and options-based position management strategies are what an investor might do to tend the portfolio while benefiting from market outcomes. And having these in your quiver at all times, with one finger in the wind of market conditions, means you are going to be positioned to get better results when times of high volatility make it possible. If you need personalized advice or someone to make choices for you, consider the services of a financial planner who can tailor strategies based on your investment goal.
