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+Chapter 36: The Basics of Volatility Trading 743 
+prediction that is somewhat "middle of the road," since an extreme prediction is 
+more likely to be wrong. Of course, it turns out to be wrong anyway, since actual 
+volatility jumps around quite rapidly. 
+The few charts that have been presented here don't constitute a rigorous study 
+upon which to draw the conclusion that implied volatility is a poor predictor of actu­
+al volatility, but it is this author's firm opinion that that statement is true. A graduate 
+student looking for a master's thesis topic could take it from here. 
+VOLATILITY TRADING 
+As a result of the fact that implied volatility can sometimes be at irrational extremes, 
+options may sometimes trade with implied volatilities that are significantly out of line 
+with what one would normally expect. For example, suppose a stock is in a relatively 
+nonvolatile period, like the price of the stock in Figure 36-2, just before point A on 
+the graph. During that time, option sellers would probably become more aggressive 
+while option buyers, who probably have been seeing their previous purchases decay­
+ing with time, become more timid. As a result, option prices drop. Alternatively stat­
+ed, implied volatility drops. When implied volatilities are decreasing, option sellers 
+are generally happy (and may often become more aggressive), while option buyers 
+are losing money (and may often tend to become more timid). This is just a function 
+of looking at the profit and loss statements in one's option account. But anyone who 
+took a longer backward look at the volatility of the stock in Figure 36-2 would see that 
+it had been much more volatile in the past. Consequently, he might decide that the 
+implied volatility of the options had gotten too low and he would be a buyer of 
+options. 
+It is the volatility trader's objective to spot situations when implied volatility is 
+possibly or probably erroneous and to take a position that would profit when the 
+error is brought to light. Thus, the volatility trader's main objective is spotting situa­
+tions when implied volatility is overvalued or undervalued, irrespective of his outlook 
+for the underlying stock itself. In some ways, this is not so different from the funda­
+mental stock analyst who is attempting to spot overvalued or undervalued stocks, 
+based on earnings and other fundamentals. 
+From another viewpoint, volatility trading is also a contrarian theory of invest­
+ing. That is, when everyone else thinks the underlying is going to be nonvolatile, the 
+volatility trader buys volatility. When everyone else is selling options and option buy­
+ers are hard to find, the volatility trader steps up to buy options. Of course, some rig­
+orous analysis must be done before the volatility trader can establish new positions, 
+but when those situations come to light, it is most likely that he is taking positions 
+opposite to what "the masses" are doing. He will be buying volatility when the major-