A decrease in value of the options from time decay causes an increase in
profitability. This profit potential pinnacles at the center (strike) price at
expiration. Rising IV will cause a decline in profitability at each stock price
point. Declining IV will raise the payout on the Y axis as profitability
increases at each price point.
Smileys and frowns are a mere graphical representation of the technique
discussed in this chapter: buying and selling realized volatility. These P&
(L) diagrams are limited, because they show the payout only of stock-price
movement. The profitability of direction-indifferent and direction-neutral
trading is also influenced by time and implied volatility. These actively
traded strategies are best evaluated on a gamma-theta basis. Long-gamma
traders strive each day to scalp enough to cover the day’s theta, while short-
gamma traders hope to keep the loss due to adverse movement in the
underlying lower than the daily profit from theta.
The strategies in this chapter are the same ones traded in Chapter 12. The
only difference is the philosophy. Ultimately, both types of volatility are
being traded using these and other option strategies. Implied and realized
volatility go hand in hand.