I decided to devote an entire chapter to describing how to analyze volatility, including its role in determining an option’s price and how to profit from changes in volatility. This chapter provides a general overview of volatility; defines implied volatility; differentiates between the different types of volatility; explains what it means for implied volatility to be expressed in terms of annual standard deviation; describes how to evaluate implied volatility prior to making a trade, how changes in circumstances can affect an option’s price, how the volatility skew can present trading opportunities, how a change in conditions can affect volatility, how to trade volatility, and how to establish a delta-neutral position; and provides various trading tips. This chapter first covers volatility considerations prior to making a trade and then covers considerations after the position is established. This chapter is not intended to cover the complex mathematical aspects of volatility but, instead, is intended to cover the concepts that can help you as a trader.
This chapter is primarily concerned with addressing implied volatility and intends “implied volatility” to mean the measurement of volatility, stated as a percentage, reflected in an option’s price. This chapter will not study the details of volatility in the context of an option pricing model or mathematical formulas.
When analyzing the price of an option, volatility is the most complex ...