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Become a Great Options Trader
Home › Forums › Market Discussion › Understanding How Volatility Expansion Works
Recent example in KMI:
By looking at the Bollinger Band width, my guess was that the stock had the potential for large price movement coming up.
Faz asks:
So you’re expecting vol to come back up again — e.g. it’s overstretched. Is this another oversold methodology? Or do you interchange your massive arsenal depending on the context?
Let’s think about the market in terms of cycles.
Markets go up, sideways, down, and sideways.
We can also view this from a market structure definition.
Markup, distribution, markdown, accumulation.
That’s a normal market cycle.
There’s another kind of market cycle I look at, from the context of the actual volatility.
We see periods of volatility compression and expansion.
If you can identify when volatility has compressed for too long then you can profit on the expansion. This is where option buying works best.
Obviously this can happen on different timeframes and so on, but the premise remains the same.
When a stock has been range bound, that means it’s in balance… also known as equilibrium.
Buyers and sellers basically agree on a price and any attempt to auction out of balance leads to reversion.
BUT
There are only so many buyers and sellers. At some point liquidity will run out, or a new catalyst in the company will cause either side to disappear.
That’s what causes volatility expansion.