Volatility is probably the most overlooked and misunderstood aspect of options trading.
The important fact is that volatility affects the price you pay for an option. In simple terms:
- Rising volatility “inflates” the value of an option
- Subsequently falling volatility “deflates” the value of an option
- Volatility in itself is not static; it rises and falls over time.
We distinguish between two types of volatility: implied volatility (IV) and statistical (or historical) volatility (SV).
Implied Volatility has a major impact on calculating the extrinsic value (time premium) of an option. It is calculated using an options pricing model such as the “Black-Scholes Model”. Such pricing models are complex mathematical formulas which are built into good trading software packages like OptionVue. As a trader it is not necessary to understand the math behind these models. What is important is to understand the results that are derived from these models and to comprehend how the information impacts on a trading decision.
Statistical or historical volatility in contrast is the volatility of an asset’s past price movement. Historical volatility looks at the actual fluctuations in price which an asset has experienced in the past. A higher historical volatility value indicates that an asset showed wider price swings than an asset with lower historical volatility. Essentially it gives us a feel for the current and near future rate of change in price in the underlying asset.
Can You Make Money Trading Volatility?
If by “trading volatility” you mean finding and entering trades by looking solely at volatility, then our answer would have to be “no”. An in-depth understanding of volatility is essential, BUT only if considered together with other market factors like time and price. You need to understand the interaction between all these elements and how they affect trade discovery, strategy selection, and trade management before you can truly master the trading process.
Volatility Trading Coach
I have spent many years analysing and studying how changes in time, price and volatility affect the profit and loss outcomes of trades. My findings have led me to develop my own unique trading strategy which today is the cornerstone of my Options Mentoring course. If you would like to learn more please don’t hesitate to contact me.