the road. The market’s apparent assessment of future volatility is unchanged
during this period. When IV rises or falls, vol traders must look to the
underlying stock for a reason. The options market reacts to stock volatility,
not the other way around.
Finding fundamental or technical reasons for surges in volatility is easier
than finding specific reasons for a decline in volatility. When volatility falls,
it is usually the result of a lack of news, leading to less price action. In this
example, probably nothing happened in the market. Consequently, the stock
volatility drifted lower. But it fell below the lowest IV level seen for the six-
month period leading up to the crossover. It was probably hard to take a
confident stance in volatility immediately following the crossover. It is
difficult to justify selling volatility when the implied is so cheap compared
with its historic levels. And it can be hard to justify buying volatility when
the options are priced above the stock volatility.
The two-week period before the realized line moved beneath the implied
line deserves closer study. With the IV four or five points lower than the
realized volatility in late January, traders may have been tempted to buy
volatility. In hindsight, this trade might have been profitable, but there was
surely no guarantee of this. Success would have been greatly contingent on
how the traders managed their deltas, and how well they adapted as realized
volatility fell.
During the first half of this period, the stock volatility remained above
implied. For an experienced delta-neutral trader, scalping gamma was likely
easy money. With the oscillations in stock price, the biggest gamma-
scalping risk would have been to cover too soon and miss out on
opportunities to take bigger profits.
Using the one-day standard deviation based on IV (described in Chapter
3) might have produced early covering for long-gamma traders. Why?
Because in late January, the standard deviation derived from IV was lower
than the actual standard deviation of the stock being traded. In the latter half
of the period being studied, the end of February on this chart, using the one-
day standard deviation based on IV would have produced scalping that was
too late. This would have led to many missed opportunities.
Traders entering hedges at regular nominal intervals—every $0.50, for
example—would probably have needed to decrease the interval as volatility