Volatility is an essential component of options trading. Nonetheless, many options traders do not pay it sufficient attention, and their returns frequently suffer as a result. When volatility is high, options buyers should be cautious about straight options buying. Rather, they should typically be looking to sell instead. Low volatility, on the other hand, generally takes place in quieter markets, and it can mean a better situation for buyers. Still, there’s no guarantee that the market will move dramatically at any time soon.
Why is volatility important to understand?
Traders who misunderstand volatility dynamics may experience sharp losses that they may have otherwise been able to avoid. Those who do understand volatility, on the other hand, may be able to use this knowledge to enhance their profit potential.
With this in mind, this tutorial has aimed to highlight the following important areas of volatility in order to provide a basis from which to explore the subject in greater depth later (suggested resources can be found below).
- Applying historical and implied volatility to pricing and valuation determination
- Getting a feel for how volatility impacts option strategies' potential risk and reward
- Acquiring insights into implied volatility skews
- Using options volatility to predict price moves
- Analyzing investor crowd psychology with options implied volatility (VIX)
To further develop your knowledge of volatility, check out "Option Volatility & Pricing: Advanced Trading Strategies and Techniques" by Sheldon Natenberg (second edition, 1994). Another recommended test is "Options As A Strategic Investment (fifth edition, 2012) by Lawrence McMillan. These two books should provide all the necessary concepts needed to fully understand volatility in all aspects of trading options.
There are also many great resources to be found online. The Chicago Board Options Exchange website is an invaluable source of information about intraday and end-of-day quotes for the VIX and other volatility indexes for major stock market averages.
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