5 Useful Volatility Trading Strategies and Key Indicators for Beginners

In this comprehensive guide, we will delve deep into five effective volatility trading strategies and key indicators to give you the ammunition you need to conquer the tumultuous terrains of the financial markets.

1. The Straddle Strategy

Strategy Explanation:
The straddle is an options trading strategy that involves buying both a call option and a put option with the same strike price and expiration date. This approach is highly suitable for periods of high market volatility.

Key Indicators:
Implied Volatility (IV): The higher the IV, the more expensive the options will be. However, a high IV often precedes a significant price movement.

Historical Volatility (HV): If the HV is substantially lower than the IV, the market may be overstating the future volatility, offering an edge.

How to Apply:
1. Identify the Asset: Select an asset expected to have substantial price movement.
2. Check Indicators: Use IV and HV to assess the cost and potential success of your straddle.
3. Buy the Options: Execute both call and put options with identical strike prices and expiration dates.
4. Monitor and Adjust: Keep a close eye on the asset’s price and be prepared to close one side of the straddle if it becomes unprofitable.

2. Volatility Arbitrage

Strategy Explanation:
In volatility arbitrage, you try to exploit the difference between the implied volatility of an option and a forecast of future realized volatility.

Key Indicators:
Implied Volatility Index (VIX): Higher VIX levels often indicate a market expectation of large price swings.

Beta: It measures an asset’s sensitivity to market movements. A high beta indicates greater volatility.

How to Apply:
1. Find the Mismatch: Spot options where the implied volatility diverges significantly from your forecast of future volatility.
2. Take Positions: If implied volatility is high, sell the option. If it’s low, buy the option.
3. Hedge Your Risk: Use delta-hedging or other methods to minimize directional risk.
4. Close the Position: Exit when the implied and expected volatilities converge or upon option expiry.

3. Iron Condor

Strategy Explanation:
An Iron Condor involves four different options contracts. This strategy profits when an asset has low volatility.

Key Indicators:
Average True Range (ATR): Measures market volatility by decomposing the entire range of an asset price for a period.
Bollinger Bands: These bands widen during periods of increased volatility and contract when volatility decreases.

How to Apply:
1. Select the Asset: Choose a stable asset, where you expect minimal price movement.
2. Examine Indicators: Use ATR and Bollinger Bands to confirm low volatility.
3. Set up the Iron Condor: Buy and sell options at both higher and lower strike prices.
4. Monitor: Watch your asset’s price and be prepared to adjust your positions to manage risk.

4. Gamma Scalping

Strategy Explanation:
This involves adjusting your options positions to become delta-neutral. As the underlying asset moves, the trader can scalp their position to remain delta-neutral.

Key Indicators:
Gamma: Shows how much the delta of an option changes when the price of the underlying asset changes by $1.
Delta: Measures how much an option’s price is expected to change per $1 change in the underlying asset.

How to Apply:
1. Set up a Straddle: Like the Straddle Strategy.
2. Monitor Gamma and Delta: Keep a close eye on these metrics.
3. Scalp to Adjust: Buy or sell shares of the underlying asset to remain delta-neutral.
4. Rinse and Repeat: Continue to adjust your position as the market moves.

5. Vega Neutral Strategy

Strategy Explanation:
The aim is to have a portfolio that is not sensitive to changes in volatility.

Key Indicators:
Vega: Measures the rate of change in an option’s price per 1% change in implied volatility.
Theta: Measures the rate of time decay of an option’s price.

How to Apply:
1. Select Options: Choose options positions with different Vega values but the same underlying asset.
2. Calculate Net Vega: Ensure the net Vega of your positions is close to zero.
3. Adjust: Use Theta and other Greeks to refine your portfolio.
4. Monitor: Keep an eye on market conditions and adjust your Vega levels accordingly.