744 Part VI: Measuring and Trading Volatility 
ity has been selling it (or at least, when the majority is refusing to buy it), and he will 
be selling volatility when everyone else is panicking to buy options, making them 
quite expensive. 
WHY DOES VOLATILITY REACH EXTREMES? 
One can't just buy every option that he considers to be cheap. There must be some 
consideration given to what the probabilities of stock movement are. Even more 
important, one can't just sell every option that he values as expensive. There may be 
valid reasons why options become expensive, not the least of which is that someone 
may have inside information about some forthcoming corporate news (a takeover or 
an earnings surprise, for example). 
Since options off er a good deal of leverage, they are an attractive vehicle to any­
one who wants to make a quick trade, especially if that person believes he knows 
something that the general public doesn't know. Thus, if there is a leak of a takeover 
rumor - whether it be from corporate officers, investment bankers, printers, or 
accountants - whoever possesses that information may quite likely buy options 
aggressively, or at least bid for them. Whenever demand for an option outstrips sup­
ply - in this case, the major supplier is probably the market-maker - the options 
quickly get more expensive. That is, implied volatility increases. 
In fact, there are financial analysts and reporters who look for large increases in 
trading volume as a clue to which stocks might be ready to make a big move. 
Invariably, if the trading volume has increased and if implied volatility has increased 
as well, it is a good warning sign that someone with inside information is buying the 
options. In such a case, it might not be a good idea to sell volatility, even though the 
options are mathematically expensive. 
Sometimes, even more minor news items are known in advance by a small seg­
ment of the investing community. If those items will be enough to move the stock 
even a couple of points, those who possess the information may try to buy options in 
advance of the news. Such minor news items might include the resignation or firing 
of a high-ranking corporate officer, or perhaps some strategic alliance with another 
company, or even a new product announcement. 
The seller of volatility can watch for two things as warning signs that perhaps 
the options are "predicting" a corporate event (and hence should be avoided as a 
"volatility sale"). Those two things are a dramatic increase in option volume or a sud­
den jump in implied volatility of the options. One or both can be caused by traders 
with inside information trying to obtain a leveraged instrument in advance of the 
actual corporate news item being made public.