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+Chapter 31,: 1be Basics of Volatility Trading 747 
+implied volatility is high. Given that fact, he can then construct positions around a 
+neutral strategy or around his view of the future. The time when the volatility seller 
+must be careful is when the options are expensive and no one seems to know why. 
+That's when insider trading may be present, and that's when the volatility seller 
+should defer from selling options. 
+CHEAP OPTIONS 
+When options are cheap, there are usually far less discernible reasons why they have 
+become cheap. An obvious one may be that the corporate structure of the company 
+has changed; perhaps it is being taken over, or perhaps the company· has acquired 
+another company nearly its size. In either case, it is possible that the combined enti­
+ty's stock will be less volatile than the original company's stock was. As the takeover 
+is in the process of being consummated, the implied volatility of the company's 
+options will drop, giving the false impression that they are cheap. 
+In a similar vein, a company may mature, perhaps issuing more shares of stock, 
+or perhaps building such a.., good earnings stream that the stock is considered less 
+volatile than it formerly was. Some of the Internet companies will be classic cases: In 
+the beginning they were high-flying stocks with plenty of price movement, so the 
+options traded with a relatively high degree of implied volatility. However, as the com­
+pany matures, it buys other Internet companies and then perhaps even merges with a 
+large, established company (America Online and Time-Warner Communications, for 
+example). In these cases, actual (statistical) volatility will diminish as the company 
+matures, and implied volatility will do the same. On the surface, a buyer of volatility 
+may see the reduced volatility as an attractive buying situation, but upon further 
+inspection he may find that it is justified. If the decrease in implied volatility seems 
+justified, a buyer of volatility should ignore it and look for other opportunities. 
+All volatility traders should be suspicious when volatility seems to be extreme -
+either too expensive or too cheap. The trader should investigate the possibilities as to 
+why volatility is trading at such extreme levels. In some cases, the supply and demand 
+of the public just pushes the options to extreme levels; there is nothing more involved 
+than that. Those are the best volatility trading situations. However, if there is a hint 
+that the volatility has gotten to an extreme reading because of some logical (but per­
+haps nonpublic) reason, then the volatility trader should be suspicious and should 
+probably avoid the trade. Typically this happens with expensive options. 
+Buyers of volatility really have little to fear if they miscalculate and thus buy an 
+option that appears inexpensive but turns out not to be, in reality. The volatility buyer 
+might lose money if he does this, and overpaying for options constantly will lead to 
+ruin, but an occasional mistake will probably not be fatal.