Master volatility trading for the Derivatives exam. Learn about implied vs. historical volatility, VIX, volatility strategies, and Vega exposure management.
Volatility Trading for Derivatives Exam
Volatility is a key input to option pricing and a tradeable asset class itself. Understanding volatility strategies is essential.
Implied vs. Historical Volatility
Historical Volatility
- Calculated from past price movements
- Backward-looking measure
- Standard deviation of returns
- Different time periods give different values
Implied Volatility
- Derived from option prices
- Forward-looking market expectation
- Reflects supply/demand for options
- Can differ from historical volatility
The VIX
- "Fear index" - S&P 500 implied volatility
- Calculated from option prices
- Generally negatively correlated with market
- VIX futures and options tradeable
- Term structure: spot vs. futures VIX
Volatility Strategies
Long Volatility
- Buy straddles or strangles
- Profit from large price moves
- Direction doesn't matter
- Time decay works against you
Short Volatility
- Sell straddles or strangles
- Profit from low volatility/stability
- Collect premium
- Risk of large losses if market moves
Volatility Skew
- IV varies by strike price
- OTM puts often higher IV (skew)
- Reflects demand for downside protection
- Can trade skew directly
Managing Vega Exposure
- Vega: sensitivity to volatility
- Long options: positive Vega
- Short options: negative Vega
- Portfolio Vega management
Key Exam Topics
- IV vs. HV differences
- VIX interpretation
- Long vs. short volatility strategies
- Volatility skew
- Vega exposure management
Tags:volatility tradingVIXimplied volatility