Volatility Trading Strategies

Abstract

In this chapter, I will discuss what may be the most creative of the options strategies, volatility trades. As previously explained, volatility is essentially the risk aspect of the market. It is the perception of risk that is “securitised” in the time value component of an option premium. The volatility can be implied in the options price (which includes traders’ expectations of future price movements) or be based upon the actual fluctuations in the price of the asset which underlies the option. As I mentioned in Chapter 4, there are three ways to measure volatility. One method is the historical basis which measures what has happened in the past and is expressed as the annualised standard deviation of percentage changes in the underlying asset. The second method is the implied volatility which is the current volatility associated with the option’s price. Finally, there is the method of volatility estimation which forecasts future volatility by using econometric techniques which incorporate both the historical and implied techniques.