Trading Volatility
Len Yates

Volatility trading, called V-trading for short, has two attractive sides. First, there are always trading opportunities, no matter what’s going on in the general market. More importantly, there is always a position you can take that places the odds in your favor. I might enjoy playing in Las Vegas, but the odds there are definitely not in my favor!

That’s why V-trading is better, way better. The essence of V-trading is buying cheap options and/or selling expensive options, typically holding until the options return to fair valuation levels. So why is it called volatility-based trading?

We call it volatility-based trading because of the way option cheapness or dearness is measured – using implied volatility (IV). Each option implies how volatile its underlying is. A cheap option implies that its underlying is going to be very quiet. An expensive option implies that its underlying is going to be very volatile. Typically all the options of a particular asset move to higher or lower levels of implied volatility at the same time.

The important thing is that just as prices sometimes move to unreasonable extremes, so does IV. To implement V-trading you consider buying cheap options, as indicated by a current IV that is low by historical standards. When IV is extremely high, indicating expensive options, you should consider selling options.

Thus the old adage "buy low and sell high" applies to V-trading just as well as to price trading. In fact, it applies even more reliably to V-trading. A price can range from zero to infinity. Volatility cannot range that far. So when volatility does go to an extreme, it is just a matter of time before it returns to normal levels.

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