Chapter 39: Volatility Trading Techniques 817 
someone may have inside information that justifies expensive options. This is another 
reason why selling volatility can be difficult: You may be dealing with far less infor­
mation than those who are actually making the implied volatility high. 
COMPARING IMPLIED AND HISTORICAL VOLATILITY 
The most common way that traders determine which options are cheap or expensive 
is by comparing the current composite implied volatility with various historical 
volatility measures. However, just because this is the conventional wisdom does not 
necessarily mean that this method is the preferred one for determining which options 
are best for volatility trades. In this author's opinion, it is inferior to the percentile 
method (comparing implied to past measures of implied), but it does have its merits. 
The theory behind using this method is that it is a virtual certainty that implied and 
historical volatility will eventually converge with each other. So, if one establishes 
volatility trading positions when they are far apart, there is supposedly an advantage 
there. 
However, this argument has plenty of holes in it. First of all, there is no guar­
antee that the two will converge in a timely manner, for example, before the options 
in the trader's position can become profitable. Historical and implied volatility often 
remain fairly far apart for weeks at a time. 
Second, even if the convergence does occur, it doesn't necessarily mean one will 
make money. As an example, consider the case in which implied volatility is 40% and 
historical volatility is 60%. That's quite a difference, so you'd want to buy volatility. 
Furthermore, suppose the two do converge. Does that mean you'll make money? No, 
it does not. What if they converge and meet at 40%? Or, worse yet, at 30%? You'd 
most certainly lose in those cases as the stock slowed down while your options lost 
time value. 
Another problem with this method is that implied volatility is not necessarily 
low when it is bought, nor high when it is sold. Consider the example just cited. We 
merely knew that implied volatility was 40% and that historical volatility was 60%. We 
had no perspective on whether 40% was high, medium, or low. Thus, it is also nec­
essary to see what the percentile of implied volatility is. If it turns out that 40% is a 
relatively high reading for implied volatility, as determined by looking at where 
implied volatility has been over the past couple of years, then we would probably not 
want to buy volatility in this situation, even though implied and historical volatility 
have a large discrepancy between them. 
Many market-makers and floor traders use this approach. However, they are 
often looking for an option that is briefly mispriced, figuring that volatilities will