The Secrets of Volatility Skew in Options Trading…

Understand volatility before is too late…

As a trader with 16+ years of experience. It's crucial to understand the intricacies of options trading, and one key concept that often confuses traders is volatility. 

In this email, we'll dive into:

1. How volatility affects option pricing

2. How it affects your trading decisions

3. Why it's essential to grasp this concept to improve your trading performance.

In simplest terms, all options are priced based on the probability of a strike expiring at-the-money. 

THE KEY 🔑 FACTOR in knowing what the probability of something expiring at-the-money is Volatility. 

Volatility refers to the implied move by expiration. 

You can quickly factor an implied move by adding the at-the-money strike of both the put and the call on any underlying for any expiration. 

In order to make money, an option buyer needs the underlying to:

1️⃣Exceed the implied move by expiration. 

or… 

2️⃣Have the implied move increase before expiration.

Some people avoid trading options because volatility is “too high” this is a common misunderstanding as well. 

Sometimes high volatility is justified. Sometimes it’s understated. 

What a savvy options trader does is compare realized implied volatility to historical or realized volatility. 

Here’s a glimpse of what we teach in the School of Gains:

• Realized Volatility:

  • Lay definition: How much the stock has moved around lately

  • Textbook definition: The annualized standard deviation of an asset price

  • Synonyms: Historical volatility

• Implied Volatility:

  • Lay definition: How cheap or expensive options are

  • Textbook definition: The volatility figure that when entered in an options-pricing model yields a theoretical value reflecting current market prices

  • The volatility “implied” by options prices

Once you understand these differences, you’ll quickly be able to spot opportunities where options are under or over priced. 

THIS is what we teach in the School of Gains.

Understanding volatility is crucial because it directly impacts your ALL option pricing through the “greeks”. 

Most options teachers will talk about delta, or theta or maybe even gamma but at Paper Gains, we focus on volatility. 

For the simple reason that volatility actually changes your primary greeks through what’s called second order greeks. 

Here’s a quick glimpse of what you’ll learn in the School of Gains:

Ignoring volatility can lead to suboptimal trades and missed opportunities.

There are MANY more nuances to options pricing and how it’s tied to volatility but to take your options trading to the next level, I strongly encourage you to study volatility in-depth. 

• Analyze historical data 

• Observe how skew changes during different market conditions

• Incorporate this knowledge into your trading plan 

By doing so, you'll gain a significant edge in the market and be better equipped to navigate the complexities of options trading.

I’ll leave you with the link for today’s Weekly Trade Plan Video.

Where we go in-depth explaining charts, analysis, and news.

Rooting for you,

Paper Gains.