Lesson 11: Vol Trading Intuition
Promise: Develop intuition for when to buy vol, when to sell vol, and how to think about the volatility risk premium.
Buying vs Selling Volatility
At its core, every options trade is a vol trade. Even if you're trading direction, you're implicitly taking a vol position.
Every options position is a bet on realized vol vs implied vol.
The Volatility Risk Premium
The volatility risk premium (VRP) is one of the most important concepts in vol trading.
The pattern: On average, implied vol exceeds realized vol. Option sellers collect this premium.
Why it exists:
- Options provide insurance
- Insurance commands a premium
- Most participants are hedgers (natural buyers)
- Someone must be compensated for taking the other side
Historical VRP
The Catch
VRP is positive on average. But:
- It can go negative (realized > implied)
- When it goes wrong, it goes very wrong (fat tails)
- Selling vol is picking up nickels in front of steamrollers
When to Buy Vol
Buy vol when you think realized will exceed implied:
Good Times to Buy
Bad Times to Buy
When to Sell Vol
Sell vol when you think implied exceeds what will realize:
Good Times to Sell
Bad Times to Sell
The best vol sales are after vol spikes, not before them.
Expressing Vol Views
Pure Vol Bets (Delta-Neutral)
| Strategy | Vol View | Risk Profile |
|---|---|---|
| Long straddle | Long vol | Pay theta, need big move |
| Short straddle | Short vol | Collect theta, unlimited risk |
| Long strangle | Long vol, cheaper | Need even bigger move |
| Short strangle | Short vol | Collect premium, tail risk |
Vol + Direction
| Strategy | View | Risk Profile |
|---|---|---|
| Long call | Bullish + long vol | Limited loss, unlimited gain |
| Short put | Bullish + short vol | Collect premium, downside risk |
| Put spread | Bearish, reduced vol exposure | Capped loss and gain |
| Call spread | Bullish, reduced vol exposure | Capped loss and gain |
Term Structure Bets
| Strategy | View | Risk Profile |
|---|---|---|
| Calendar (sell near, buy far) | Near-term vol will crush | Benefit from term structure normalization |
| Reverse calendar | Near-term vol will rise | Benefit from term structure inversion |
Risk Management for Vol Trading
Position Sizing
Vol trades can have extreme outcomes. Size accordingly:
- Long vol: Max loss is premium. Can size more aggressively.
- Short vol: Potential loss is large. Size conservatively.
Stop Losses
- Long vol: Time is your enemy. Cut if thesis invalidated.
- Short vol: Define max loss. Have a plan for vol spikes.
Diversification
- Don't concentrate vol exposure at one expiry
- Spread across strikes when selling
- Consider term structure diversification
The Psychology of Vol Trading
Buying Vol
- Feels painful: constant theta bleed
- Requires patience: waiting for the move
- Temptation: close early to "salvage" premium
- Reality: a few big wins pay for many small losses
Selling Vol
- Feels good: daily theta collection
- Breeds complacency: "easy money"
- Temptation: size up after winning streak
- Reality: one blow-up can erase months of gains
Selling vol feels like winning until you lose. Buying vol feels like losing until you win.
Common Mistakes
| Mistake | Correction |
|---|---|
| Buying vol after it's already spiked | You're paying the fear premium. Often too late. |
| Selling vol in low-vol environments | Premium is thin. Risk/reward is poor. |
| Not understanding VRP | Know that IV > RV on average, but not always. |
| Ignoring events when selling | Short gamma into events is dangerous. |
| Sizing short vol too aggressively | One spike can wipe out months of gains. |
| Holding long vol too long | Theta decay is relentless. Have an exit plan. |
Putting It All Together
The complete vol trader thinks about:
- Where is vol in its range? (High/low percentile)
- What's the term structure saying? (Events priced?)
- What's skew doing? (Fear direction)
- What's my VRP expectation? (Will realized exceed implied?)
- What's my risk if wrong? (Scenario analysis)
- Is the trade sized appropriately? (Can survive being wrong)
💡 Tip: Try answering each question yourself before revealing the answer.
Congratulations!
You've completed Reading Volatility (1→2).
You now understand:
- How the vol surface works as a 3D map of expectations
- What skew, term structure, and smile shapes reveal
- How surfaces move and what movements signal
- Advanced Greeks (vanna, volga, charm) and portfolio-level thinking
- How to read market signals from vol data
- When to buy vs sell volatility
Next steps:
- Practice reading live vol surfaces on Deribit or Hypercall
- Paper trade vol strategies to build intuition
- Explore the Volatility Reference for deeper dives
See Also
Navigation: ← Lesson 10: What the Market is Telling You | Course Home →