Forward volatility (volatility trading strategy)

AI & Machine learning
1

Course name: "Options Trading Strategies In Python: Intermediate"

Section 9 (Volatility Trading Strategies)



The video says that if forward volatility is greater than the implied volatility of the option with the shorter expiration date, one should short the longer-term option and long the shorter-term option because the shorter-term option appears to be cheaper (or the longer-term option is more costly).



Can anyone elaborate in detail on this point?



Thanks!

2

Hi Georgius,



So basically, if there is no news expected in the market between the expiry of the short-term and the long-term option, then the implied volatility of the short-term option should be ideally equal to the forward volatility of the long-term option. But when this is not the case, there is a mispricing in the options i.e the short term option seems to be cheaper and the long term option seems to be costly. Hence one can go long on the short term option and short the long term option.



Hope this helps!



Thanks,

Akshay