Options Trading Strategies – Wrong Use of Historical Volatility and Implied Volatility Crossovers


All volatilities are not built equal. It is essential to differentiate between historical volatility and implied volatility, so that retail traders learn how to trade options by focusing on what is important to theoretically value futures option spreads.

Historical volatility (HV) measures past price movements of the underlying asset by recording the actual or realized volatility of the asset. The most well-known type of HV is statistical volatility, which calculates the return on the underlying assets over a limited but adjustable number of days. Let me explain to you what “finished but adjustable” means. You can vary the number of days to measure statistical volatility: for example, 5-10-50-200 days, this is how time-based moving averages and moment / oscillator studies are built. However, this is not the case with implied volatility.

Implied volatility measures expected values ​​by repeatedly refining bid-ask estimates. These estimates are based on the expectations of buyers and sellers. Buyers and sellers (over 85% of floor traded volume is pulled by institutions, floor traders and market makers) behind long and short values, which change their estimates within the day, as news information, whether it is macro or micro news – economic data having an impact on the underlying product becomes available. What is estimated are the future fluctuations of the underlying asset with certain assumptions built into the information changes of the underlying. This refinement of bid-ask estimates should be done in time-limited option expiration periods. This is why there are monthly and quarterly option expiration cycles. You can't change these expiration periods, either shortening or lengthening the number of days, to "build" a period that gives you faster or slower crossover metrics.

Why report the misuse of crossovers of historical volatility and implied volatility? This is to warn you about the improper use of HV-IV crossovers, which are not a reliable trading signal. Remember that for any given expiration month there can only be one volatility in that specific time period. Implied volatility must leave where it is currently trading to converge to zero on the expiration date. Implied volatility (be it IV for ITM, ATM, or OTM strikes) should return to zero upon expiration; but the price can go anywhere (go up, down or stay flat).

Continually selling 'overvalued' options and buying 'undervalued' options would eventually cause the implied volatility of every nonzero long option to line up exactly. This means that the phenomenon of the "smiling" bias of IV disappears, because IV becomes perfectly flat. This rarely happens, especially in very liquid products. Take for example the SPY, a broad-based index; or, GLD – the SPDR Shares ETF in a market as fast as gold. With an open interest in non-zero auction strikes ranging into the thousands and tens of thousands, do you really think a retail floor trader is going to be allowed to 'price' the professional hedger out? floor? Unlikely. Calls and puts in highly liquid products are like items in an inventory with a high supply because there is high demand. This type of inventory is not 'badly priced' because floor traders have to make a living from trading calls and puts on a daily basis – they will refuse to bear the risk of a daily price error. on the next day.

So what are the main considerations relating to banking to your advantage as a retail trader?

  • The percent impact of IV on an option's extrinsic value is much larger for ATM and OTM strikes, compared to ITM strikes which are loaded with intrinsic value but lacking extrinsic value. Most retail options traders with an account size between $ 25,000 and $ 50,000 (or less), are drawn to ATM and OTM strikes for the sake of accessibility. The deeper the ITM, the wider the bid-ask spread compared to the narrower bid-ask spread differences in ATM or OTM keystrokes, making ITM keystrokes more costly to to negotiate.
  • When you trade IV, you buy time decay for an IV increase one% point below; or, the time premium sale for an IV drop to a percentage point above the notional market value price, which participants are willing to pay or sell. Depending on the market ranges on that day, the price debit spreads should be filled 0.10-0.15 below the theoretical spread price. With credit spreads, increase the credit to sell the spread 0.10-0.15 above the theoretical price of the spread. The price you pay below; or, receiving above the theoretical price of a spread is your advantage, based only on the price performance of the implied volatility only. Remember that you are theoretically pricing a spread to fill the order for its forward value, never back.

Where can I learn to trade options with constant earnings focused on implied volatility without historical volatility? Follow the link below titled 'Consistent Results' to see a model retail options trader's portfolio that excludes the use of HV and focuses on IV trading only.

I am going to quote these actual historical events, to strengthen the argument for removing historical volatility from your trading process altogether.

February 27, 2007: Widespread panic due to the massive sell off of stocks in China. If you trade the options of an index like FXI, which is the iShares product of the 25 largest and most liquid Chinese companies in China, despite being listed in the US; but they are headquartered in China, you would have been impacted. While you can argue that it is possible for market events to recreate the ranges of the Dow, Nasdaq, and S&P, how do you recreate the scenario of the VIX and VXN rising 59% and 39%?

Jan 22, 2008: The Fed cuts rates by 75 basis points ahead of the policy meeting scheduled for January 30, whereby the FOMC cut an additional 50 basis points as of the meeting date. If you are trading interest rate sensitive areas using the options of a financial ETF or a banking index like BKX; or, the housing index like the HGX, you would have been hit. And in the current environment of near zero rates, the FOMC while it still has a tariff policy tool, is unable to lower rates by the same number of basis points as it does. 39; before. What was a historic event cannot be repeated in succession in the future, until rates are raised again and they are cut again afterwards.

Question: How do you reconstruct the story? This is the story of the events forming historical volatility. The answer is in the actual examples cited, as with any other financially related historical event – you cannot reconstruct history. You may be able to imitate parts of HV, but you cannot repeat it in its entirety. So if you continue to use HV-IV crossovers, you visually get confused by looking for volatility “wrong pricing” patterns that you would like to see; but you will end up with poor profit performance instead. It makes more sense to focus only on IV; then, diversify volatility trading across multiple asset classes beyond equities.

Where can I learn more about IV trading on multiple asset classes using options only, without having to own stocks? Follow the link below (video course), which uses IV Mean Reversion / Mean Repulsion and IV Forecasting, as reliable methods to trade implied volatilities on stock indices, commodity ETFs, currency ETFs and emerging market ETFs.


  1. Today, I went to the beach front with my kids. I found a sea shell and gave it to
    my 4 year old daughter and said “You can hear the ocean if you put this to your ear.” She placed the shell to her ear and screamed.

    There was a hermit crab inside and it pinched her ear.
    She never wants to go back! LoL I know this is entirely off topic but
    I had to tell someone!


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