1. Option Volatility: Introduction
  2. Option Volatility: Why Is It Important?
  3. Option Volatility: Historical Volatility
  4. Options Volatility: Projected or Implied Volatility
  5. Options Volatility: Valuation
  6. Option Volatility: Strategies and Volatility
  7. Option Volatility: Vertical Skews and Horizontal Skews
  8. Option Volatility: Predicting Big Price Moves
  9. Option Volatility: Contrarian Indicator
  10. Options Volatility: Conclusion

By John Summa, CTA, PhD, Founder of OptionsNerd.com

Trading options without an understanding of volatility is like operating on a patient without knowing what role blood flow plays in the human body. When volatility is high, buyers of options should be wary of straight options buying, and they should be looking instead to sell options. Low volatility, on the other hand, which generally occurs in quiet markets, will offer better prices for buyers; however, there's no guarantee the market will make a violent move anytime soon.

Unfortunately, too many traders launch into trading without the proper knowledge of the ABCs of Option Volatility. A misunderstanding of volatility's dynamics can lead to painful losses, which otherwise might not have been experienced. A proper understanding of volatility, on the other hand, can inject enhanced profit potential into strategies.

Toward this end, this tutorial has highlighted the following essential areas of volatility to provide a basis to explore the subject in greater depth later (see suggested resources below).

  1. Understanding the difference between historical and implied volatility
  2. Applying historical and implied volatility to pricing and valuation determination
  3. Getting a feel for how volatility impacts option strategies' potential risk and reward
  4. Acquiring insights into implied volatility skews
  5. Using options volatility to predict price moves
  6. Analyzing investor crowd psychology with options implied volatility (VIX)

To further develop you 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 (fourth edition, 2002) by Lawrence Mcmillan. These two books should provide all the necessary concepts needed to fully understand volatility in all aspects of trading options.

Online sources of information include the Chicago Board Options Exchange website, where you can get intraday and end-of-day quotes for the VIX (implied volatility index) and other volatility indexes on major stock market averages. Additional volatility data is available at the CBOE website for individual stocks.


Related Articles
  1. Trading

    Implied Volatility: Buy Low and Sell High

    This value is an essential ingredient in the option pricing recipe.
  2. Trading

    What is Meant by Implied Volatility?

    The estimated volatility of a security's price.
  3. Trading

    Option Price-Volatility Relationship: Avoiding Negative Surprises

    Learn about the price-volatility dynamic and its dual effect on option positions.
  4. Insights

    Low Volatility? You Have Options

    With volatility at record lows, options have never been cheaper.
  5. Trading

    Ratio Writing: A High-Volatility Options Strategy

    Selling a greater number of options than you buy profits from a decline back to average levels of implied volatility.
  6. Investing

    Understand the Risks of Trading Inverse ETFs

    Inverse ETFs sound like a great way to take advantage of market volatility. But it's important to understand how they work before you invest.
  7. Investing

    Volatile Stocks: Great, If You Have The Stomach

    Volatile stocks can be a lucrative opportunity for short-term traders. For buy-and-hold investors, it's a much different story.
  8. Trading

    Stock Options: What's Price Got To Do With It?

    A thorough understanding of risk is essential in options trading. So is knowing the factors that affect option price.
Frequently Asked Questions
  1. What's considered to be a good debt-to-income (DTI) ratio?

    Your debt-to-income ratio helps lenders determine your credit worthiness. Find out how to calculate your score and how to ...
  2. What is the difference between a loan and a line of credit?

    Learn to differentiate between lines of credit and standard loans, and determine when you are likely to use each method of ...
  3. What does a Chief Financial Officer (CFO) do?

    A CFO is responsible for accurate reporting of a company's financial information, investing the company's money and identifying ...
  4. How did George Soros break the Bank of England?

    George Soros pocketed $1 billion by betting against the British pound, cementing his reputation as the premier currency speculator ...
Trading Center