746 Part VI: Measuring and Trading Volatility 
the order of those with insider information might come into the pit to buy options, 
but the market-makers may not sell them many, preferring to raise their offering 
price rather than sell a large quantity. If this happens a few times in a row, the options 
will have gotten very expensive as the floor broker raises his bid price repeatedly, but 
only buys a few contracts each time. Meanwhile, the market-maker keeps raising his 
offering price. 
Eventually, the floor broker concludes that the options are too expensive to 
bother with and walks away. Perhaps his client then buys stock. In any case, what has 
happened is that the options have gotten very expensive as the bids and offers were 
repeatedly raised, but not much option volume was actually traded because of the 
illiquidity of the contracts. Hence the normal warning light associated with a sudden 
increase in option volume would not be present. In this case, though, a volatility sell­
er should still be careful, because he does not want to step in to sell calls right before 
some major corporate news item is released. The clue here is that implied volatility 
literally exploded in a short period of time (one day, or actually less time), and that 
alone should be enough warning to a volatility seller. 
The point that should be taken here is that when options suddenly become very 
expensive, especially if accompanied by strong stock price movement and strong 
stock volume, there may very well be a good reason why that is happening. That rea­
son will probably become public knowledge shortly in the form of a news event. In 
fact, a major market-maker once said he believed that rrwst increases in implied 
volatility were eventually justified - that is, some corporate news item was released 
that made the stock jump. Hence, a volatility seller should avoid situations such as 
these. Any sudden increase in implied volatility should probably be viewed as a 
potential news story in the making. These situations are not what a neutral volatility 
seller wants to get into. 
On the other hand, if options have become expensive as a result of corporate 
news, then the volatility seller can feel more comfortable making a trade. Perhaps the 
company has announced poor earnings and the stock has taken a beating while 
implied volatility rose. In this situation, one can assess the information and analyze it 
clearly; he is not dealing with some hidden facts known to only a few insider traders. 
With clear analysis, one might be able to develop a volatility selling strategy that is 
prudent and potentially profitable. 
Another situation in which options become expensive in the wake of market 
action is during a bear market in the underlying. This can be true for indices, stocks, 
and futures contracts. The Crash of '87 is an extreme example, but implied volatility 
shot through the roof during the crash. Other similar sharp market collapses - such 
as October 1989, October 1997, and August-September 1998 - caused implied 
volatility to jump dramatically. In these situations, the volatility seller knows why