I recently received a question that can be paraphrased as:
Lately I’ve noticed Implied Volatility (IV) being much higher than Historical Volatility (HV) on individual equities that are trending bullish. When trading long at-the-money calls, my positions sometimes drop in value or gain less value than they should even when the stocks are trading in the right direction. Can I minimize the volatility risk on these ascending stocks by trading deep in-the-money calls or are there other things I should look at?
First I want to answer the question about trading longs in such a way that minimizes volatility, but then I want to address the issue of volatility itself. If we recognize a volatility discrepancy that is tradable—like escalated IV—it behooves us not to skirt the issue, but to use it to our advantage. After all, option pricing anomalies created by volatility are one of an option trader’s purest forms of edge and ignoring this is as much of a mistake as a swing trader ignoring price chart patterns.Read More