836 Part VI: Measuring and Trading Volatility 
you do both, though, you create a "good news, bad news" situation. The good news 
is that the maximum risk is reduced; for example, if XYZ goes exactly to 130 (the 
worst point for the call spread), the companion put spread's credit would reduce that 
risk a little. However, the bad news is that there is a much wider range over which 
there is not profit, since there are two spots where losses are more or less maximized 
(at the strike price of the long calls and again at the strike price of the long puts). 
Margin will be discussed only briefly, since it was addressed in the chapter on 
reverse spreads. For both index and stock options, this strategy is considered to have 
naked options - a preposterous assumption, since one can see from the profit graph 
that the position is fully hedged until the near-term options expire. This raises the 
capital requirement for nonmember traders. The margin anomaly is not a problem 
with futures options, however. For those options, one need only margin the differ­
ence in the strikes, less any credit received, because that is the true risk of the posi­
tion. In summary, the volatility trader who wants to sell volatility in equity and futures 
options markets needs to be hedged, because gaps are prevalent and potentially very 
costly. This strategy creates a more neutral, less price-dependent way to benefit if 
implied volatility decreases, especially when compared with simple credit spreads. 
SUMMARY: TRADING THE 
VOLATILITY PREDICTION 
Attempting to establish trades when implied volatility is out of line is a theoretically 
attractive strategy. The process outlined above consisted of a few steps, employing 
both statistical and theoretical analysis. In any case, though, probability calculators 
must "say" that a volatility trade has good probabilities of success. It's merely a mat­
ter of what criteria we apply to limit our choices before we run the probability analy­
sis. So, it might be more useful to view volatility trading analysis in this light: 
Step I: Use a selection criterion to limit the myriad of volatility trading choices. Any 
of these could be used as the first criterion, but not all of them at once: 
a. Require implied volatility to be at an extreme percentile. 
b. Require historical and implied volatility to have a large discrepancy 
between them. 
c. Interpret the chart of implied volatility to see if it has reversed trend. 
Step 2: Use a probability calculator to project whether the strategy can be expected 
to be a success. 
Step 3: Using past price histories, determine whether the underlying has been able 
to create profitable trades in the past. (For example, if one is considering