{"id":21432,"date":"2020-03-30T13:47:43","date_gmt":"2020-03-30T12:47:43","guid":{"rendered":"https:\/\/traders-paradise.com\/magazine\/?p=21432"},"modified":"2021-10-12T12:23:28","modified_gmt":"2021-10-12T11:23:28","slug":"volatility-trading-how-to-trade-volatility-profitably","status":"publish","type":"post","link":"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/","title":{"rendered":"Volatility Trading &#8211; How To Trade Volatility Profitably?"},"content":{"rendered":"<p>(Updated November 2021)<\/p>\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_74 counter-hierarchy ez-toc-counter ez-toc-grey ez-toc-container-direction\">\n<div class=\"ez-toc-title-container\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Table of Contents<\/p>\n<span class=\"ez-toc-title-toggle\"><a href=\"#\" class=\"ez-toc-pull-right ez-toc-btn ez-toc-btn-xs ez-toc-btn-default ez-toc-toggle\" aria-label=\"Toggle Table of Content\"><span class=\"ez-toc-js-icon-con\"><span class=\"\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/span><\/a><\/span><\/div>\n<nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Volatility_traders_do_not_pay_attention_to_which_direction_stock_prices_move_they_are_interested_in_the_level_of_volatility_itself\" >Volatility traders do not pay attention to which direction stock prices move, they are interested in the level of volatility itself.<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#But_firstly_we_would_like_to_make_clear_what_volatility_trading_is\" >But firstly, we would like to make clear what volatility trading is.<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Factors_important_to_determine_the_volatility\" >Factors important to determine the volatility<\/a><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#First_of_all_it_is_one_of_the_%E2%80%9CGreeks%E2%80%9D_%E2%80%93_Vega\" >First of all, it is one of the &#8220;Greeks&#8221; &#8211; Vega.\u00a0<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Main_points_related_to_volatility_trading\" >Main points related to volatility trading<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Strategies_for_volatility_trading\" >Strategies for volatility trading<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Straddle_strategy\" >Straddle strategy<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#In_Forex_trading\" >In Forex trading<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-9\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Ratio_Writing\" >Ratio Writing<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-10\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Iron_Condors_in_volatility_trading\" >Iron Condors in volatility trading<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-11\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Go_long\" >Go long<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-12\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Go_Short\" >Go Short<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-13\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Use_VIX_to_predict_the_volatility\" >Use VIX to predict the volatility\u00a0<\/a><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><ul class='ez-toc-list-level-4' ><li class='ez-toc-heading-level-4'><a class=\"ez-toc-link ez-toc-heading-14\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/#Bottom_line\" >Bottom line<\/a><\/li><\/ul><\/li><\/ul><\/li><\/ul><\/nav><\/div>\n<h4><span class=\"ez-toc-section\" id=\"Volatility_traders_do_not_pay_attention_to_which_direction_stock_prices_move_they_are_interested_in_the_level_of_volatility_itself\"><\/span><img loading=\"lazy\" decoding=\"async\" class=\"alignnone size-full wp-image-21433\" src=\"https:\/\/traders-paradise.com\/magazine\/wp-content\/uploads\/2020\/03\/volatility-trading-t-1.jpg\" alt=\"Volatility Trading - How To Trade Volatility Profitably?\" width=\"800\" height=\"533\" \/><br \/>\n<strong>Volatility traders do not pay attention to which direction stock prices move, they are interested in the level of volatility itself.<\/strong><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><span style=\"font-weight: 400;\">Volatility trading describes trading the volatility of the price of an underlying asset. Make a note of the difference, it isn&#8217;t trading of the price itself. Or in other words, volatility trading indicates trading the assumed future volatility of the index. Hence, it is buying and selling the anticipated future volatility of the asset. Every single asset in which price changes, actually manifests price volatility. So, traders that trade volatility looks at how much change, in any direction, will happen. They don&#8217;t pay attention to the price, they don&#8217;t want to predict the price itself. Such traders just think about how much the price of some asset will move in the future, in the stock price, for example. No matter if it will go up or down. And it isn&#8217;t random trading. They have developed strategies which we&#8217;ll present to you.<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"But_firstly_we_would_like_to_make_clear_what_volatility_trading_is\"><\/span><b>But firstly, we would like to make clear what volatility trading is<\/b><span style=\"font-weight: 400;\">.<\/span><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">For example, options are a favorite tool for volatility trading. Why is that? Well, many factors can affect the value of the option but a crucial for its value is the expected future volatility of the underlying asset. Hence, options with higher expected volatility are more valuable than options on instruments with low expected volatility in the future.<br \/>\n<\/span><span style=\"font-weight: 400;\">Therefore, options represent an easy way to get exposure to the volatility of the underlying instruments. Basically, that expected future volatility of the underlying instrument of an option is a very important part when traders&#8217; valuing the option.<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"Factors_important_to_determine_the_volatility\"><\/span><b>Factors important to determine the volatility<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">We can recognize seven factors that determine the price of an option and they are also called variables. While all of them are variable only one is an estimate and represents the most important part. The known factors are the current price of an underlying asset, strike price, also the known part is calls and puts, meaning what is the type of an option. Further, we always know what is the risk-free interest rate, and the dividends on the underlying assets. But what we don&#8217;t know is volatility. The volatility is the most important variable to determine the price of an option. So we need to know what indicates volatility.\u00a0<\/span><\/p>\n<h4><span class=\"ez-toc-section\" id=\"First_of_all_it_is_one_of_the_%E2%80%9CGreeks%E2%80%9D_%E2%80%93_Vega\"><\/span><b>First of all, it is one of the &#8220;Greeks&#8221; &#8211; Vega.\u00a0<\/b><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><span style=\"font-weight: 400;\">It is the measure of an option&#8217;s price sensitivity to shifts in the volatility of the underlying instrument. Vega outlines the value that an option&#8217;s price changes as a response to a 1% move in the expected volatility of the underlying asset. This &#8220;greek&#8221; will show the change of an option for every 1% of the change in volatility.\u00a0<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"Main_points_related_to_volatility_trading\"><\/span><b>Main points related to volatility trading<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">Traders should pay attention to two main points related to volatility.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">One is relative volatility. It refers to the current volatility of the stock in comparison to its volatility over a given period. For example, ABC stock options that expire in one-month historically showed expected volatility of 15%, but current volatility is 25%. Let&#8217;s compare it with XYZ stock options that had expected volatility of 25% but now grown to 30%. If we want to estimate absolute volatility it is obvious that XYZ stock has a greater. But the stock ABC gained a greater change in relative volatility.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The volatility of the overall market is important too. The most used is VIX ( the CBOE Volatility Index) that measures the volatility of the <\/span><a href=\"https:\/\/en.wikipedia.org\/wiki\/S%26P_500_Index\"><span style=\"font-weight: 400;\">S&amp;P 500<\/span><\/a><span style=\"font-weight: 400;\">. VIX is also known as the investors&#8217;\u00a0 fear gauge. When the S&amp;P 500 experiences a sharp decline, the VIX increases sharply. Every time when the S&amp;P 500 is rising gradually, the VIX will be pacified.\u00a0<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Strategies_for_volatility_trading\"><\/span><b>Strategies for volatility trading<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<h3><span class=\"ez-toc-section\" id=\"Straddle_strategy\"><\/span><b>Straddle strategy<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">As we said, traders who trade volatility are not interested in the direction of the price changes. They make money on high volatility, no matter whether the price goes up or down.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">One of the most popular strategies for volatility trading is the Straddle strategy with pending orders. This strategy provides a profit when the price goes considerably in one direction, no matter if it is up or down. The best time to use this strategy is when the traders expect an extreme increase in volatility.\u00a0\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">We said it has to be used with pending orders. The pending orders are orders that were not yet executed, hence not yet becoming a trade. They&#8217;ll become market orders when certain pre-specified conditions are met.<br \/>\n<\/span><span style=\"font-weight: 400;\">If you want to use this strategy, you&#8217;ll need to identify a market in consolidation before some significant market release. Further, set a buy stop pending order above the upper consolidation resistance. A sell stop pending order you should set below the lower consolidation support.\u00a0\u00a0<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"In_Forex_trading\"><\/span><b>In Forex trading<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">For example, you are trading Forex and have a currency pair that entered a consolidation stage with low volatility. Just put buy stop orders a few pips above the upper resistance,\u00a0 so a sell stop order should be a few pips below the lower support. No matter in which direction the price will change, it will trigger one of these orders and when the volatility continues, the trade will end up in a profit.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">The real trigger for pending orders is volatility. Volatility occurs a bit before important reports in the market and traders usually schedule this kind of trades before them.<br \/>\n<\/span><span style=\"font-weight: 400;\">In a straddle strategy, the traders write or sell a call and put at the same strike price wanting to receive the premiums on both positions. The reason behind this strategy is that the traders await expected volatility to decrease significantly by option expiry. That allows them to hold most of the premiums received on short put and short call positions.<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"Ratio_Writing\"><\/span><b>Ratio Writing<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/ratios-important-to-make-profit-in-stocks\/\"><span style=\"font-weight: 400;\">Ratio<\/span><\/a><span style=\"font-weight: 400;\"> writing is simply writing more <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/what-is-options-trading\/\"><span style=\"font-weight: 400;\">options<\/span><\/a><span style=\"font-weight: 400;\"> than are bought. Use a 2:1 ratio, just two options, sold or written for every option bought. The aim is to profit on a large fall in expected volatility before the date of expiry.<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"Iron_Condors_in_volatility_trading\"><\/span><b>Iron Condors in volatility trading<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">In this strategy, the traders combine a bear call spread with a bull put spread of the same expiration. They hope to profit on a reversal in volatility. The result would be the stock trading in a tight range during the life of the options.<br \/>\n<\/span><span style=\"font-weight: 400;\">The iron condor strategy has a low payoff, but the potential loss also has a limitation.<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"Go_long\"><\/span><b>Go long<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">During the high volatility, traders who are <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/the-bear-market-starts-how-to-avoid-big-losses\/\"><span style=\"font-weight: 400;\">bearish<\/span><\/a><span style=\"font-weight: 400;\"> on the stock can buy puts on it. Keep in mind the saying &#8220;the trend is your friend.&#8221;<br \/>\n<\/span><span style=\"font-weight: 400;\">\u201cGo long\u201d strategy or buy puts is expensive. It requires, from traders who want to lower the costs of long put positions, to buy more put out-of-the-money or, the other way is to add a short put position at a cheaper price to meet the cost of the long put position. You can find this strategy under the name a bear put spread.<\/span><\/p>\n<h3><span class=\"ez-toc-section\" id=\"Go_Short\"><\/span><b>Go Short<\/b><span class=\"ez-toc-section-end\"><\/span><\/h3>\n<p><span style=\"font-weight: 400;\">The other name for this strategy is &#8220;write calls&#8221;. The traders who are bearish on the stock but think the level of expected volatility for options could decrease may write naked calls to pocket a premium.<br \/>\n<\/span><span style=\"font-weight: 400;\">Writing or shorting a naked call is a very risky strategy, keep that in mind. There can be an unlimited risk if the underlying stock boosts in price before the expiry date of the naked call position. In such a case, you can end up with several hundred percent of the loss. To reduce this risk, just combine the short call position with a long call position at a higher price. This strategy you can find under the name &#8220;a bear call spread.&#8221;<\/span><\/p>\n<h2><span class=\"ez-toc-section\" id=\"Use_VIX_to_predict_the_volatility\"><\/span><b>Use VIX to predict the volatility\u00a0<\/b><span class=\"ez-toc-section-end\"><\/span><\/h2>\n<p><span style=\"font-weight: 400;\">Yes, you can recognize market turns by using VIX. To be more specific,\u00a0 you&#8217;ll recognize the bottoms. Well, the stock market regularly rises gradually and the VIX will decrease in the same manner. So very low levels can occur. The investors don&#8217;t feel they need any protection. If these periods last longer, the VIX as a sell signal can be useless.\u00a0<\/span><\/p>\n<p><span style=\"font-weight: 400;\">But, the nature of the S&amp;P 500 is long-biased. If index declines investors start to buy protection (simple put options) fast. That pushes up the VIX. Can you see how great the &#8220;fear barometer&#8221; VIX is? When you notice a high VIX you can be sure the investors and traders are overreacting because the market drops. The VIX during times of market drops will behave as the spike. That is a good signal to discover when selling is overdone and the market is moving higher due to bounce or even bottom for a longer-term.<\/span><\/p>\n<p><span style=\"font-weight: 400;\">This strategy is suitable when the VIX \u2018sign\u2019 appears during a bullish trend in the S&amp;P 500.<\/span><\/p>\n<h4><span class=\"ez-toc-section\" id=\"Bottom_line\"><\/span><b>Bottom line<\/b><span class=\"ez-toc-section-end\"><\/span><\/h4>\n<p><span style=\"font-weight: 400;\">Volatility trading is an excellent way to get <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/a-dead-cat-bounce-how-to-trade-it\/\"><span style=\"font-weight: 400;\">profitable trades<\/span><\/a><span style=\"font-weight: 400;\"> even if you are wrong about the direction of the price. Volatility is the main interest of volatility traders. They are seeking big changes in any direction. Use the VIX index as a measurement for volatility in the stock market. A rising VIX index indicates fears in the market. But it is a good time to buy stocks. The most popular <\/span><a href=\"https:\/\/traders-paradise.com\/\"><span style=\"font-weight: 400;\">trading strategy<\/span><\/a><span style=\"font-weight: 400;\"> to trade volatility is the Straddle strategy.<br \/>\n<\/span><span style=\"font-weight: 400;\">Also, traders use the Short Straddle strategy when they expect a lack of volatility, for example, the prices continuing with steady change.<br \/>\n<\/span><span style=\"font-weight: 400;\">No matter which of these strategies <\/span><a href=\"https:\/\/traders-paradise.com\/magazine\/recommends\/wallstreetwindow\/\"><span style=\"font-weight: 400;\">you want to use<\/span><\/a><span style=\"font-weight: 400;\">, just keep in mind that you can profit no matter what is the direction of the price movement.<\/span><\/p>\n","protected":false},"excerpt":{"rendered":"<p>(Updated November 2021) Volatility traders do not pay attention to which direction stock prices move, they are interested in the level of volatility itself. Volatility trading describes trading the volatility of the price of an underlying asset. Make a note of the difference, it isn&#8217;t trading of the price itself. Or in other words, volatility [&hellip;]<\/p>\n","protected":false},"author":4,"featured_media":21434,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"content-type":"","_exactmetrics_skip_tracking":false,"_exactmetrics_sitenote_active":false,"_exactmetrics_sitenote_note":"","_exactmetrics_sitenote_category":0,"footnotes":""},"categories":[1016,1012],"tags":[1779,264,1781,1780,1778,1782,182,151,143,104,1777],"class_list":["post-21432","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-how-to-master-in-trading-advanced","category-traders-secrets","tag-how-to-trade-volatility","tag-investors","tag-investors-fears","tag-market-fears","tag-profitable-strategies-for-volatility-trading","tag-profitable-trading","tag-stock-market","tag-stocks","tag-traders","tag-trading","tag-volatility-trading"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v25.1 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>Volatility Trading - How To Trade Volatility Profitably? - Traders-Paradise<\/title>\n<meta name=\"description\" content=\"(Updated November 2021) We can recognize seven factors that determine the price of an option and they are also called variables. While all of them are variable only one is an estimate and represents the most important part.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/traders-paradise.com\/magazine\/2020\/03\/volatility-trading-how-to-trade-volatility-profitably\/\" \/>\n<meta property=\"og:locale\" content=\"en_GB\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Volatility Trading - How To Trade Volatility Profitably? - Traders-Paradise\" \/>\n<meta property=\"og:description\" content=\"(Updated November 2021) We can recognize seven factors that determine the price of an option and they are also called variables. 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