Volatility Trading Strategies

In this section, we 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 ‘securitized’ in the time value component of an option premium. As mentioned in Chapter 2, 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 annualized standard deviation of percentage changes in the underlying asset. The second 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.