Beginning Volatility Arbitrage Trading
Investors profit from option and futures implied volatility disparities via volatility arbitrage. This strategy is popular among experts, but beginners may apply it.
Understand financial market volatility before mastering volatility arbitrage. The price fluctuation of a financial instrument over time is termed volatility. Low volatility suggests price stability; high volatility shows price fluctuation.
Arbitrage capitalizes on financial instrument volatility mispricing. Actual volatility is the asset’s past price, whereas implied volatility is the market’s forecast.
If implied volatility is considerably higher than historical volatility, volatility arbitrageurs may sell an option, anticipating actual volatility to be lower. Arbitrageurs may purchase options with lower implied volatility than historical volatility, expecting more volatility than market expectations.
The volatility arbitrage methods include straddles, strangles, and ratio spreads. Before trading, beginners must understand the risks and apply these strategies.
Benefits of volatility arbitrage
Investors may profit from volatility arbitrage. Advantages include:
Volatility discrepancies may provide substantial gains if detected and utilized.
Diversification: Volatility arbitrage is independent of asset price, thus traders may diversify.
Hedging: Volatility arbitrage may protect traders against market fluctuations.
Volatility Arbitrage Risks
Like any trading approach, volatility arbitrage includes risks.
Limited profit potential: Options and derivative premiums limit substantial profits.
Market expectations may change quickly in volatility arbitrage, resulting in losses if trades are not made quickly.
Market risk: Market crashes or unexpected news may destabilize financial instruments and volatility arbitrage.
Conclusion
Volatility arbitrage may benefit experienced traders but be risky for beginners. Its potential profits, diversification, and hedging attract traders.
Trading is risky, and financial market success needs extensive research, experience, and learning.
References and sources:
1. Investopedia. “Volatility Arbitrage.” https://www.investopedia.com/terms/v/volatilityarbitrage.asp
2. Options Education. “Introduction to Volatility Arbitrage.” https://cdn.cboe.com/resources/education/pdf/een_volatility_arbitrage.pdf
3. Wikipedia. “Volatility Arbitrage.” https://en.wikipedia.org/wiki/Volatility_arbitrage