Think you can just watch the market and make money trading options?

Wrong.

If you don't get how volatility works, you're just gambling.

Let me show you how volatility can make or break your trades.

If you're just starting out, you might have heard terms like "implied volatility" and "realized volatility" but aren't quite sure what they mean. Don't worry!

By the end of this newsletter, you'll have a solid understanding of these concepts and how they can help you make better trading decisions.

## #1 What is Volatility?

First things first, let's talk about volatility.

In simple terms, volatility is how much and how quickly the price of an asset (like a stock or an index) moves up or down. If the price changes quickly, we say it's very volatile.

If the price doesn't change much, we say it's not very volatile.

### Implied Volatility: A Peek into the Future

Implied volatility is like a crystal ball that helps traders guess how much the price of an asset might change in the future.

But instead of magic, this crystal ball uses math! When traders look at the price of an option (a type of contract that gives you the right to buy or sell an asset at a set price), they can figure out what the market expects future volatility to be.

This expected volatility is what we call "implied volatility."

Imagine you're at a carnival and see a game where you can win a prize if you guess the number of jellybeans in a jar. Now, let's say the price to play the game goes up. This probably means people think it's getting harder to guess the number of jellybeans, so they expect more surprises—more "volatility."

That's kind of like how implied volatility works with options.

### Realized Volatility: Looking Back at What Happened

While implied volatility is about guessing the future, realized volatility is about looking at the past.

It's like reading the score after a game to see how many points were scored. Realized volatility measures how much the price of an asset actually changed over a certain period. For example, if we look at how much a stock's price jumped around last month, that's the realized volatility.

It tells us how bumpy the ride has been.

## #2 Why Should You Care?

Now, you might wonder, "Why should I care about these different types of volatility?"

Well, if you're trading options, understanding volatility is super important. Here's why:

### Options Pricing:

The price of an option depends a lot on volatility.

When you buy an option, you're making a bet on how much the asset's price will move. If you think the asset's price will change a lot, you might be willing to pay more for the option. That's where implied volatility comes in.

It helps set the price of the option based on what the market thinks will happen.

### Making Profits:

The money you make (or lose) from trading options—what traders call "Profit and Loss" or P/L—depends on both implied and realized volatility.

If you own an option, you want the actual price changes (realized volatility) to be bigger than what the market expected (implied volatility).

That's because bigger price moves mean more opportunities to make money.

## #3 The Battle Between Realized and Implied Volatility

In the world of options trading, there's always a battle between realized volatility and implied volatility.

If you're a buyer of options, you're hoping that the realized volatility (what actually happens) is bigger than the implied volatility (what the market expected). This way, you can make enough money from Gamma to cover the losses from Theta and still come out ahead. On the other hand, if you're selling options, you want the realized volatility to be smaller than the implied volatility.

This way, you get to keep the money from selling the option because the price didn't move as much as the buyer hoped.

So, there you have it!

Understanding implied and realized volatility is critical to making intelligent trading decisions. Knowing how these two types of volatility interact can help you plan your trades better, whether you're buying or selling options.

Remember, as a trader, you're always trying to find that sweet spot where you can profit from the differences between what the market expects (implied volatility) and what actually happens (realized volatility).