818 Part VI: Measuring and Trading Volatility 
quickly revert back to where they were. But for a position trader, the problems cited 
above can be troublesome. 
Having said that, if one looks to implement this method of trying to determine 
when options are out of line, something along the following lines should be imple­
mented. One should ensure that implied volatility is significantly different from all of 
the pertinent historical volatilities. For example, one might require that implied 
volatility is less than 80% of each of the 10-, 20-, 50-, and 100-day historical volatili­
ty calculations. In addition, the current percentile of implied volatility should be 
noted so that one has some relative basis for determining if all of the volatilities, his­
torical and implied, are very high or very low. One would not want to buy options if 
they were all in a very high percentile, nor sell them if they were all in a very low per­
centile. 
Often, a volatility chart showing both the implied and certain historical volatili­
ties will be a useful aid in making these decisions. One can not only quickly tell if the 
options are in a high or low percentile, but he may also be able to see what happened 
at similar times in the past when implied and historical volatility deviated substan­
tially. 
Finally, one needs some measure to ensure that, if convergence between 
implied and historical volatility does occur, he will be able to make money. So, for 
example, if one is buying a straddle, he might require that if implied rises to meet his­
torical (say, the lowest of the historicals) in a month, he will actually make money. 
One could use a different time frame, but be careful not to make it something unrea­
sonable. For example, if implied volatility is currently 40% and historical is 60%, it is 
highly unlikely that implied would rise to 60% in a day or two. Using this criterion 
also ensures that the absolute difference between implied and historical volatility is 
wide enough to allow for profits to be made. That is, if implied is 10% and historical 
is 13%, that's a difference of 30% in the two - ostensibly a "wide" divergence 
between implied and historical. However, if implied rises to meet historical, it will 
mean only an absolute increase of 3 percentage points in implied volatility - proba­
bly not enough to produce a profit, after costs, if any length of time passes. 
If all of these criteria are satisfied, then one has successfully found "mispriced" 
options using the implied versus historical method, and he can proceed to the next 
step in the volatility analysis: using the probability calculator. 
READING THE VOLATILITY CHART 
Another technique that traders use in order to determine if options are mispriced is 
to actually try to analyze the chart of volatility - typically implied volatility, but it 
could be historical. This might seem to be a subjective approach, except that it is real-