Volatility is such a vital concept, but it’s commonly misunderstood.  You can’t trade for a living without knowing volatility inside and out.  In this episode, I introduce some powerful strategies to harness volatility for profit, but not before laying out the foundations such as: how to measure historical volatility, the difference between historical and expected future volatility (e.g. the VIX), and the reasons why markets often misprice volatility.


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(CC image by Daniel Rodriguez on Flickr)

Section 1: Historical Volatility

Section 2: Future Volatility

  • All about the VIX (the “fear index”) – definition, how it’s traded, limitations
  • Factors that impact the market’s expectation of volatility for a stock or an index
  • Mean-reversion
  • Volatility risk premium

Section 3: Volatility & Options (Calls and Puts)

  • Expected volatility across different strike prices and expiration dates
  • Impact of volatility on option pricing
  • Vega: one of the Greek letters used by options traders

Section 4: Using the VIX as a Portfolio Hedge

  • Definition of a hedge
  • VIX ETFs or ETNs
  • Buying or selling VIX options
  • Better methods for hedging your assets against volatility, if that’s your goal

Section 5: How to Trade Volatility Without Going Broke

  • Stop trading VIX ETFs and ETNs!  Just stop!
  • Writing OTM options has been called “picking up nickels in front of a steamroller” by those who don’t know the correct way to do it
  • Study the examples of those who failed: Karen the Supertrader, Vic Niederhoffer (see Resources section below)
  • Set reasonable goals
  • Write close-to-the-money, at-the-money or in-the-money options instead of deep OTM
  • Layer fundamental analysis on top of technical analysis
  • Multiple layers of technical analysis, such as intermarket analysis to find confirmation or divergence
  • No “autopilot”!! – Manage positions carefully throughout their lifespan
  • Three simple trading strategies based on volatility
  • Complex strategy, but not really so hard to learn: The Options Ladder – stay tuned, more details coming in the future!


Karen the Supertrader: series of interviews on TastyTrade

Karen the Supertrader – SEC fraud accusations

New Yorker article on Vic Niederhoffer, from 2007


Difference between the VIX and 30-day historical volatility of the S&P 500


Technical note: The 18% historical volatility (to be precise, 18.6%) I cited for the S&P 500 was based on a 252-trading-day lookback period.  When I use a 21-trading-day lookback period instead, I get 16.6%.  The 21-trading-day lookback period is more appropriate when drawing comparisons against the VIX because the VIX is the implied volatility 30 days (21 trading days) into the future.  I used the 21-trading-day lookback period in the chart of volatility risk premium above.


Intro music and mid-program music by audionautix.com


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