Issue 78: This Little-Known Fact Between Options Volume and Stock Volume Costs Uneducated Trader Dearly - Masters in Trading Digest

This Little-Known Fact Between Options Volume and Stock Volume Costs Uneducated Trader Dearly

Welcome to Issue 078 of Masters in Trading Digest.

In today’s Masters in Trading Digest, we discuss the 3 ways volatility can be served to help find compelling buying opportunities.

This morning’s webinar was a huge hit. Thanks to all who put the time aside to join me live. Your new eBook, Options Trading Secrets, awaits.

If you missed this morning's 9 am sit-down with Jonathan, you can still learn about the contrast between lily white options data and untrustworthy, duplicitous, and sifted-through stock volume that is reported to the retail trading community daily.

Volatility Served 3 Ways

Making Sense of Three Types of Volatility

Implied volatility is the market's forecast of a likely movement in a security's price and is considered one of the most important metrics for options traders.  It is a metric used by traders to estimate the future movement (volatility) of a security's price based on certain predictive factors. 

Traders use IV as a proxy of market risk. It is commonly expressed using percentages and standard deviations over a specified time horizon. Traders should think of Implied volatility as the amount of risk in the market right now, it’s considered the market’s risk.

Historical volatility, on the other hand, is the amount of risk priced into the market from a day’s past. Historical volatility factors the changes in underlying securities by measuring price changes over a set period of time. 

It is a less useful metric compared to implied volatility because it isn't forward-looking, but traders can certainly compare historical behavior to the market's implied volatility levels.

When there is a rise in historical volatility, a security's price will also move more than normal. At this time, there is an expectation that something will or has changed. 

If the implied volatility is dropping (the risk in the market right now), it means any uncertainty has been reduced, so things should trade as they did before any volatility spikes.  I and the likelihood of the stock market rally increases.

Depending on the intended duration of the options trade, historical volatility can be measured in increments ranging anywhere from 10 to 180 trading days.

If Implied volatility is the risk in the market right now, and historical volatility is the risk in the market from days past, let’s now discuss the final vol: theoretical volatility.

Theoretical volatility is the trader's volatility. Theoretical volatility is your volatility (or my volatility). Experienced traders use historical volatility, and implied volatility as data points to back into their specific “theoretical volatility”.

For example, let’s say $SNAP has a historical volatility of 40%, and it’s trading in the market with an implied volatility of 80%. It is clear risks are elevated.

The present risk in $SNAP (IV) is 2x the historical volatility. Let’s say the $VIX (a broad measure of volatility) is trading at 24. Historically the $VIX trades close to 16. A trader may conclude that $SNAP is potentially expensive using the data shared above (in this very simplified example). 

The $VIX is trading 50% higher than its historical average price, while the $SNAP volatility is trading 100% higher.

Does this mean $SNAP is expensive? Perhaps, but now traders should take a dive down this rabbit hole to find comparable volatility levels to $SNAPs peer group ($FB, $TWTR, $PINS).

What’s the Implied Volatility of other securities that are closely correlated to $SNAP?  

This is how you can back into messing around with Implied, Historical and Theoretical Volatility.

HOW DO TRADERS AT MASTERS IN TRADING USE THE 3 TYPES OF VOLATILITY?

The foundation of how we trade options is we use our proprietary scanning software to track the most unusual option trades in the market. 

When ‘smart money’ makes an ‘unusually sized trade, the AI-powered Wall Street Wiretapper flags the trade and then determines if the markets Implied Volatility is more or less than the our softwares Theoretical level.

WHEN unusual options activity signals a potential alert, the trades that show up on Wiretapper have the highest probability of outperforming the markets implied volatility levels.

The software is simple to use but learning the intricacies of Unusual Options Activity may take some understanding.

This mornings webinar explains Wall Street Wiretapper, discusses the difference between Options volume and Stock volume, and even touches on my 15yr olds Baseball Career – Listen Now.

Masters in Trading Digest - Issue 78

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FINAL THOUGHTS

WHAT TO EXPECT IN THE NEXT MIT DIGEST

The stock market is closed on Monday, so our Wall Street Wiretapper trades will be shared Monday by 5 PM EST.

Keep your feedback coming into support@mastersintrading.com. We’re excited to share your feedback along with fantastic suggestions for upcoming issues.

Until then, trade smart and always manage your tail-risk.

Thanks for reading,
Jonathan Rose

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