These 4 Lessons Allowed Me to Stop Trading Directionally

Over the course of the next 45 minutes, we are going to completely change the way that you view the markets and get you ready to start trading volatility, not necessarily direction. I'm Jim Schultz, Finance PhD. I've been trading for nearly 20 years now and trading volatility specifically through options for almost 10.

Now, naturally, let's begin by addressing the elephant in the room. If you're bullish and the market goes up, things are going to work out pretty well. If you're bearish and the market goes down, things are going to work out pretty well—like you're going to make money.

So don't get me wrong, direction matters, and during the times when you're able to actually nail the directional move, things work out pretty well and they're pretty easy. The problem is, no one really knows where the market is going next— not me, not you, not anybody. You might have a hunch; you might have a feeling that this stock is going this way or this market is going that way, and so by all means, you know, do that.

Follow those hunches—we all do that; I do that, you should do that. But the important thing to do is just put it in its place, understand what it really is in the sea of randomness that is the short-term directional moves in the market. What I want to do in this crash course is show you how you can take the emphasis off of something like direction, that's very unpredictable, and put it on something like volatility, that might just have a little bit of predictability in it.

To begin that journey, let's make sure that we're all on the same page when it comes to option profitability. When it comes to generating returns and achieving profitability, there are essentially three factors involved: direction, time, and volatility. When most people get into trading, they focus exclusively on direction without paying much attention to time or volatility.

But given just how random and unpredictable the market is, I think that order of operations is backwards. Trading direction can certainly come, but it should come after time and after volatility. With options, and even more specifically short options, we can shift our emphasis away from needing to be right directionally and instead trade the simple passage of time and the expansions and contractions of volatility—two non-directional metrics in the marketplace that can serve as the foundation to your portfolio.

One of the first things that you're going to notice when you shift your focus away from direction and onto volatility is that you will have just unlocked a whole new world of analysis that is now available to you. One additional thing that you're going to discover when you shift your focus onto volatility, when it comes to your analysis, is that you now have a whole new way to diversify your portfolio—not only the risk that you're exposed to, but also the opportunities that you find when it comes to your existing positions and the new trades that you might be looking at. For most traditional investors, volatility and huge spikes in volatility are not normally well received.

Because if I'm a traditional investor and I'm invested just passively long in, you know, SPY, then I'm just looking to ride the gradual movement higher in that stock or in that index over time. When volatility spikes, that usually means the market is suffering a significant drop, so that's clearly not going to be good for your traditional passively long investor. But for you, when volatility comes, that's simply going to mean more opportunity.

It could be exactly what you've been waiting for to deploy more capital into short option strategies and take advantage of the volatility spikes. But also, from a diversification standpoint, there's one other thing to make mention of. While market prices and market volatility have clearly shown to exhibit an inverse relationship—a rather reliable inverse relationship over time—where when market prices go up, market volatility is typically going down, and when market prices go down, market volatility is typically going up.

This relationship is not one-for-one and it is also not perfect. There will be plenty of times when market prices are up and market volatility is up, or market prices are down and market volatility is down. That's important because it clearly illustrates the simple fact that volatility is its own independent metric in a lot of ways.

So it's going to give you a way, an avenue to diversify the exposure in your portfolio that you simply cannot get by just shifting assets into, you know, fixed income or currencies or precious metals. So, as we get underway in this crash course, here is the first major takeaway: trade volatility first, not direction. Doing so is going to shift the foundation of your portfolio away from the randomness and the unpredictability of day-to-day market movements.

So here we are inside of the Tastytrade platform, and I just want to offer a brief overview of a few of the things that are relevant when it comes to market-wide volatility. On the left-hand side here, forward SLV VX—so this guy right here—this is going to be your volatility futures going out to whatever the front month might be, which I believe right now is going to be November. So, forward/SV VX is now trading at 20.

40. The other market-wide volatility metric that is commonly used, if I scroll down on this watch list, is going to be the VIX itself. So this is your market-wide volatility; this is often referred to as the fear indicator or the fear gauge in the marketplace.

Right now, you have VIX trading at 19. 21. So in terms of trying to get some type of idea regarding what is market-wide volatility doing, oftentimes.

. . Traders will look at future volatility, so for VX, wherever the Futures Contract might be right now, we're trading the VCycle or the VIX.

The VIX, which is kind of your spot volatility or your current volatility, let's say I'm looking at Apple. If I go into the quote overview of Apple, so I've got Apple loaded up in the ticker box, I bring over this right-hand sidebar that's available inside of Tasty Trade, and I click on the overview. If you look down at this IV Index, this is going to give you, just in one number, what the implied volatility is for Apple.

The reason why this is important is because, for specific stocks, it's a bit of a misnomer to say the implied volatility of Apple is X. The reason why is simply because every single stock has a myriad of implied volatilities associated with it; different expirations have different implied volatilities, and different strikes within those expirations have different implied volatilities. Case in point, for Apple, you see the IV index is 28.

6. If I go to the trade page, I simply look at the different expiration cycles; look at how the implied volatilities differ from one cycle to the next. Now, you can make the case that's not a big difference, but that's not really the point.

The point is there are different numbers associated with different expiration cycles. And then, if I open up an expiration cycle, like let's say, open up November right here with 41 days to go, and you start looking at the different strikes that are available inside of that expiration, you're going to see different implied volatilities. If I change this dropdown menu, one of these dropdowns, from extrinsic value to implied volatility, you can clearly see that now I have a number of implied volatilities inside the same expiration cycle for the different strikes that are available inside that cycle.

So again, it's a bit of a misnomer to say the implied volatility for Apple is X, but Tasty Trade does a nice job of kind of giving us this average implied volatility by taking a lot of the relevant metrics that exist for that stock and giving us just one number. So we have some idea of whether or not we're dealing with a high-volatility stock or a low-volatility stock, especially when we're comparing, you know, Apple versus Proctor and Gamble. Now, the next metric that I wanted to go ahead and at least introduce you to at this point—we're going to have a lot more to say about this as the crash course moves on—but the IV rank.

So right up here, you see this IVR for Apple is 44. 9. Now later on, I'm going to explain what that number means; I'm going to explain how we use it in trading volatility and all of those things.

But just know right now that when it comes to shifting your focus away from trading direction and now trading something like volatility, where the foundation of your portfolio is going to look a lot different from what it was when you were so focused on direction exclusively, looking at metrics like implied volatility, looking at metrics like IV rank, these are going to be a big part of what you do on a daily basis. So I simply wanted to introduce you to these ideas right here. And right now, what I want to do is talk more specifically about the nature of volatility, how it changes, and why that's important for us as active traders.

So volatility is fluid and dynamic, just like every other metric in the financial marketplace, and this might surprise you, but many of the financial models that we use every single day actually assume constant volatility in the marketplace. The reason why that is the case is that allowing for changing volatility in financial modeling—a phenomenon more formally referred to as heteroskedasticity—really complicates the fine-tuning that's necessary in these models to capture the complexities of the real markets, even if they can only do so partly. But for us as practitioners, as traders, we're not really super concerned with the theoretical obstacles that, you know, academia might run into; we just want to know, "Hey, how can I improve the risk-return profile of my portfolio?

" And so that's why something like heteroskedasticity might present a lot of problems to, you know, financial academia. For us as traders, it's actually a really, really big deal because it gives us a ton of opportunity. Case in point, when it comes to market conditions, you basically have three different states that the market could fall into from a volatility standpoint: you have expansion, you have contraction, and you have lows.

As Julia shows in figure 2. 2 inside of "The Unlucky Investor's Guide to Option Trading," volatility expansion occurs 10% of the time, volatility contraction occurs 20% of the time, and volatility lows occur 70% of the time. As the name implies, volatility expansions are when volatility is rising quickly, volatility contractions are when volatility is falling quickly, and volatility lows are when the volatility is typically stable, with a general tendency to slow grind lower over time as the market slowly rises.

Well, it is these different states that we want to take advantage of, and in a perfect world, it would be simple: we would just sell volatility when volatility is contracting or we're inside of a volatility low, and then buy volatility when volatility is expanding. But unfortunately, that perfect world is not the world that we live in and that we trade in, so we are always up against the randomness and the unpredictability of the market, and we can never know with certainty what's going to happen next. Still, we can use.

. . These empirical findings to our advantage.

Doing this, we find that volatility is usually moving lower, either quickly during a contraction or slowly during a low, and this accounts for roughly 90% of the days in the market. It is only 10% of the time that volatility is significantly expanding. It's fairly easy to see that selling volatility would appear to give us a far greater number of opportunities than buying volatility.

This is the case because selling volatility can benefit greatly from volatility contractions or volatility lows, whereas buying volatility might only be able to cash in during those far more seldom volatility expansions. To be fair, we are painting with a fairly wide brush here. Volatility sellers can certainly make money during volatility expansions, and volatility buyers can also make money during volatility contractions.

P&L is multifactorial; however, it doesn't change the fact that if you're in a market where volatility wants to go lower, where volatility is usually falling, man, you're going to have a far easier time being on the short side of that volatility trade than you would being on the long side of that volatility trade. No one knows what's going to happen next when it comes to market volatility. There might actually be just a wee little bit of predictive power that we can tap into.

You know, if I go into a stock like Amazon, let's say, and I go into the trade page, and I'm inside of November with 41 days to go, I've got my expected move right there in the center of the screen. You know, if I set up something like a short call spread to be bearish on the stock, you know, I sell a 195 call and I buy a 200 call. You know, this is a very, very classic short premium strategy that's defined risk.

You can see the maximum loss is 335, the maximum profit is 165, and all the other trade metrics that are associated with this trade. But now, let's say I clear this away and I want to do something that's undefined risk, and maybe I have a neutral bias on Amazon. So I could just, you know, I could sell a 170 put just going right outside the expected move there, and I could sell a 205 call going right outside the expected move on the upside.

And now I have a neutral strategy where I'm going to benefit the most from Amazon staying between my strikes. If I go over to the curve view here, you'll see that a bit more clearly. Curve, you click on the analysis button, and you can see the P&L diagram that is just nicely presented here inside of Tasty Trade.

It kind of shows us where we make money, where we lose money, where our risk is, our break-even points, and all of those things. Just kind of painting with a very, very broad brush to show you what is available inside Tasty Trade. And these are only two short premium strategies.

There's a whole another hemisphere with long premium and debit strategies, and we'll look at those a bit later inside of this course. Specifically, going back to the table view, take a look at one of the metrics. So you have a couple of drop-down columns where you can select different variables to look at for your trade analysis, and you can see I could choose, you know, theta, gamma, and all kinds of other metrics.

Well, right here I have Vega selected for a reason. Vega is one of the Greeks that is a first derivative of the Black-Scholes model, and it shows us how sensitive that strike is going to be to any changes in volatility because it's going to show you how many cents my option contract is going to move by when volatility changes by one point. Here's the most important part for what we're trying to do here: it's not so much the magnitude of the Vega; it's actually just the sign of the Vega.

When it comes to specifically a strategy like a short call spread, right? When I have a short call spread, and you can see I'm selling the 195 strike, I'm going to be short 24 Vega. I'm buying the 200 strike, I'm going to be long 22 Vega.

The net result there is minus 2 Vega, so you are going to be short Vega; you are going to be short volatility; you are going to be able to benefit from any falling volatility. Let's clear this strategy away and let's look at an altogether different strategy. If I were to sell a strangle, let's say, just using the expected move as my anchor for strike selection.

If I sell the 170 put and I sell the 205 call, let's say just kind of outside the expected move on both sides. The most important part here is yes, you can look at probabilities, you can look at credits, you can look at deltas and thetas. And the thing that I want to look at right now, though, is the Vega impact of this strategy.

Remember, if you sell an option, you're negative Vega; if you buy an option, you're positive Vega. Now, when we looked at the call spread just a second ago, we were selling one option and buying another option as part of the spread, so we had to take the difference to figure out what our net Vega exposure was. Well, when you have a strategy like a strangle, this is something that can really capitalize on falling volatility because you are selling options on both sides of the market.

I'm selling a 170 put and an 18 Vega, and I'm selling a 205 call and a 19 Vega. So there's no watering down effect; there's no buying back Vega from long options in the strategy like we saw with the call spread. My point and.

. . My purpose of doing this right now is just to show you the potential of what shifting your focus away from direction can do for you by looking at things like volatility, by looking at things like IVR, which we're going to look at a bit later on, and by looking at things like option Vega to actually capture and measure just how sensitive your positions are to any changing volatility that might happen in the marketplace.

What you're going to see next might shock you. Volatility has been shown to possess a mean-reverting characteristic, and to understand what that means, we could actually take a few approaches. We could take a mathematical approach, we could take an intuitive approach, or we could take an empirical approach.

So let's take a look and discuss each of those three. First, mathematically, many academics and researchers over the years have demonstrated—and powerfully so—that we can assume market volatility is what is known as a stationary process; a process where any data points that lead the variable in question away from its mean are met with additional data points that fight to bring the variable back to its mean. In other words, what goes up must eventually come back down, and vice versa.

Second, we could take an intuitive approach to volatility mean reversion. Given the natural ebb and flow of the financial markets, global events, and just the natural uncertainty in the world, it makes a lot of sense that periods of steadiness and stability (low volatility) will be followed by some kind of shock at some point. Volatility expansion in periods of chaos (high volatility) will be followed by calm (volatility contraction).

That's very intuitive, and it just makes a lot of sense. But third, and most relevant for our purposes here, we could take an empirical approach and simply say, regardless of what the mathematical theory might support or our own intuitive analysis might suggest, what does the actual data say? Because in the end, that's all that matters, right?

I mean, that's the trump card; that's the arbiter of truth—the results themselves. Well, not surprisingly, the Tasty Live research team has looked at volatility mean reversion a number of times in a number of different ways over the years. But one study the team conducted back in August of 2022 really highlights and illustrates the power of volatility mean reversion, especially from the short side of the option contract.

So first, when looking at the VIX data that were available going back to 2000 in this study, we see that the probability of an up day or down day in the VIX itself on any random day was skewed slightly in favor of a down day in the VIX: 53 to 47. This makes sense because the probability of an up day or a down day in the overall market on any random day is skewed slightly in favor of an up day: 53 to 47. Over time, the market has experienced positive drift, so an upward bias to reflect this drift makes sense.

And since market prices and market volatility are inversely related, it then follows that we would see a slight downward bias on any random day in the VIX. But what happens after we've had a consecutive streak of down days or up days in the VIX? Do the probabilities change?

Yes, and in some pretty remarkable ways. After a series of down days in the VIX, the probabilities of what the next day will do don't change much; they stay clustered around 50/50 between an up day and a down day. But as the down day streak continues, we can see there is a slight shift in favor of the next day being an up day in the VIX, showing some volatility expansion.

So in other words, there does appear to be a tiny bit of mean reversion after volatility has been contracting for even just a short time. But the remarkable part comes after a series of up days in the VIX, because now we see something very different here: the probabilities do begin changing in some significant ways. From the very first up day, the probabilities move off of 50/50 and they begin to cluster more closely around 60/40 in favor of volatility contracting and mean reverting back to a lower level.

So when volatility is low, you could certainly make the case that this is a good environment for some long volatility strategies—some debit strategies, like a long vertical spread, a calendar spread, a diagonal spread—would be a good strategic way of thinking about how to take advantage of that environment. And while the stats might largely hang around 50/50, there might be a tiny little advantage as that streak continues in terms of a big volatility spike or some kind of volatility spike coming your way. You could certainly do that.

But the real benefit of taking advantage of volatility mean reversion is on the other side. After volatility has expanded, that's when we can step in with a short volatility strategy, like a short vertical spread, iron condor, short put, or short strangle, and take advantage of a market that has clearly shown a propensity to want to revert back to a lower level of volatility. This also lines up nicely with the different volatility conditions and volatility scenarios that we just learned about, with contractions and lulls governing 90% of the market days that we trade in the overall market.

So you take these two things together, and you have a really nice environment for short volatility trades. The big takeaway here is that the volatility mean reversion that the market has exhibited can be quite advantageous, especially from the short side of the option contract. Okay, so now we have established a new foundation of trading volatility.

We've taken a look at changing volatility, and we even have some. . .

Evidence for volatility mean reversion. What I want to do now is begin to put all these pieces together in a way that's going to help us trade. This is where taking a closer look at implied volatility and implied volatility rank come into play.

Yes, market-wide volatility metrics like the VIX or the VIX futures give you a nice context—the broader context of what might be happening, you know, relative to the overall market indexes. But when it comes to specifically selecting a strategy in a specific stock, you want to dial in; you want to really hone in your focus on what's going on in that specific stock with its implied volatility and its implied volatility rank. So let's begin with a closer look at implied volatility.

Implied volatility essentially measures how volatile that specific underlying stock is expected to be over whatever time period you might be interested in. Higher implied volatility means more volatility and wider ranges are expected in the stock, while lower implied volatility means less volatility and narrower ranges are expected in the stock. Furthermore, IV is one of the inputs into the Black-Scholes option pricing model that is used to determine what the option's price should be, along with other metrics like the stock price, the strike price, time to expiration, interest rates, and any potential dividends.

The most important thing for us here is the relationship between the option price that eventually comes out of the Black-Scholes model and the IV of the stock that goes into the Black-Scholes model. Simply put, if IV is higher, then the option price will be higher, and if IV is lower, then the option price will be lower. If you're looking for a deeper dive into all things option pricing, we actually have a separate crash course that's already on the YouTube channel, so you can give that a look whenever you're ready.

But here, the main takeaway is this: If you're buying options with repeat strategies like we've talked about before, then using these in stocks that have lower IVs can make some sense. But what's even more effective is if you're selling options with credit strategies like we've talked about before—so, short verticals, short strangles, short puts, etc. —then using these in stocks that have higher IVs can certainly make some sense.

This is an oversimplification, and implied volatility is not the only thing that you should consider when you're doing your trade analysis, as we're going to see here in just a couple of minutes. But this is a really, really good starting point for understanding how implied volatility impacts the option premium, which is going to play a big role in whatever trade you do. So now that we have a basic understanding of how implied volatility is going to impact our trading, let's shift our focus over to implied volatility rank (IVR).

While IV is a metric that gets input into the Black-Scholes model, IVR is a separate measurement that actually looks at IV relative to itself over some period of time. Let me show you what I mean. What the IVR does is it looks at the range of implied volatility for that specific stock over the last 12 months and then tells you where the current IV sits in that range.

For example, let's say the range of IVs for Apple over the last 12 months was a low of 30 IV and a high of 50 IV. If the current IV was 40, then that means Apple’s IV is right in the middle of the IV range over the last 12 months, so its IVR would be 50, showing that it's sitting at the 50th percentile of that IV range. If Apple's IV was 35, then it would be five IV points into the 20-point IV range from 30 to 50, which would be the 25th percentile—so an IVR of 25.

Similarly, let's say you've got Amazon with an IV range of 25 on the low end and 65 on the high end. Following the same process, if Amazon's current IV is 30, then it's five IV points into a 40-point IV range, which would be an IVR of 12. 5.

Now, there might also be times when you see IVRs that have moved outside the 0 to 100 boundaries. This is actually pretty simple to deal with; it simply means that the current implied volatility is either lower than the previous 12-month low or higher than the previous 12-month high. More specifically, if you see an IVR of -10, that simply means the current implied volatility is 10% lower than the previous year's low.

Or if you see an IVR of 106, that simply means that the current implied volatility is 6% higher than the previous year's high. So our big takeaway here is just as we observed volatility mean reversion when looking at the market-wide metrics like the VIX, we want to take that same principle and apply it on a stock-by-stock basis but use more finely tuned metrics that apply to that specific stock—such as their implied volatility or their implied volatility rank. That allows us to better capture any opportunities that might exist for that stock when it comes to volatility mean reversion.

And that's exactly what we're going to do next when we put all of this together and show you how to use it to begin trading volatility. But the first question you might have is, "All right, Jim, I'm ready to start trading volatility, but I got to know what actually constitutes high volatility? " which is a great question and an important question.

For the answer, we're again going to turn to the Tasty Live research team. So back in August of 2023, the research team did a very simple study showing the difference between selling. 16 Delta strangles on stocks with an IV rank below 30 and stocks with an IV rank above 30, and the key takeaways are twofold.

First, notice that regardless of the IV rank environment—under 30 IV rank or over 30 IV rank—selling premium was a profitable strategy. But second, while the win rates are essentially the same in both IV rank environments, the P&L between the two is drastically different, where your average daily P&L in the under 30 IV rank category was 25 cents a day, but the average daily P&L in the over 30 IV rank category was $1. 15 a day, or over 3 times what you earned with a lower IV rank.

Now, look, I can respect the fact that you may not want to sell volatility when an IV rank is at 4, 6, or 9 because you don't want to get caught in the whirlwind that is a huge volatility expansion. That makes sense. But if this is the first time that you're looking at short options in earnest, then I wanted to at least take a couple of seconds to point out the ubiquity of their effectiveness in all market conditions, because that might be rather surprising to you.

But by all means, when IV ranks are low and implied volatility is suppressed like that, it might be the time to mix in your debit strategies—your long verticals, your calendars, your diagonals, etc. We'll take a look at those in just a few minutes. In terms of trying to figure out where your reference point is between high volatility and low volatility, using 30 as kind of a marker in the sand in terms of high IV rank and low IV rank is a pretty good reference point; that's a pretty good starting point for your analysis.

But again, IV rank, much like everything else in the marketplace, is fluid and dynamic, and so it should be just that: a starting point for your analysis. Some traders might prefer to lower that number, so now they're looking for IV ranks of only 20 or 25, and they're comfortable selling premium. Other traders might feel a lot more comfortable when the IV ranks have really expanded to 35 or 40, and that's when they pounce with short premium strategies.

There is no right or wrong answer here; there are a number of ways that you could slice this up. But if you're just getting started and you're looking for a clear reference point, then use 30. Adjust it over time based on your style, your risk tolerance, your account size, your experience level—all those different things.

So, let's dive into Tastytrade, and let's set up some short volatility trades together. Okay, so you are now ready to begin trading volatility. Like, where do I even begin?

Tastytrade makes it fairly easy to do that. So you go inside of the hamburger menu—that's right—you click on the watchlist. Now, there are all kinds of different watchlists that you could choose from.

The two that I would strongly recommend you start with—you can play around with the other ones—start with either the Tasty Default or Tom's Watchlist. The great thing about the Tasty Default, which we'll click on here, is these are all going to be stocks that are pre-screened for liquidity. These are all the big names, the big players that everybody in the market is trading.

The next thing you want to look at is you have this IV rank as one of the dropdowns that you can go ahead and sort the list by. Well, again, if I'm looking for opportunities to sell premium, I'm going to want to click on this and sort from high to low. So I clicked on it once; now it's sorted from low to high.

I click on it again, and now it's sorted from high to low. And so now I'm in a situation where I can very clearly see the IV rank of these different stocks. You can see on the list we’ve got IBM, we’ve got Chipotle, etc.

So there are many, many, many different names to choose from. So let's say I open up Starbucks, which has an IV rank of almost 75, and the stock price is $97. I open up Starbucks, click on the trade page, and go into, let's say, the November cycle with 41 days to go.

Again, they have earnings on November 7th, so this may or may not be a good trade when it comes to putting it on right now, given the fact that so many individual stocks have earnings coming up. I'm not going to be able to avoid that right here and right now because of the time of year that we are doing this video. So let's bypass the earnings impact for the purposes of what we're trying to accomplish right now.

If I open up November, you know, let’s say that I was bullish on Starbucks. Well, one of the strategies I could use—a very popular strategy when you're bullish on a stock—is that I could sell a put spread. So I could go in here and I could sell the 95 put and I could buy the 90 put, and I will be able to collect a $1.

74 credit, 62% pop, positive theta, positive delta, of course, because it's a bullish strategy. Your P50 is 77%. My maximum loss is only the difference between the width of the spread and the credit that I collect, and so all the trade metrics are looking pretty good on this specific strategy.

But again, what I really want to focus on here is the volatility impact. You have the Vega here, where you're looking at how sensitive is this strategy to changing volatility. Well, this is a spread, so I'm selling volatility on one leg and essentially.

. . Buying volatility on the other leg, I'm short 13 Vegas here; I'm long 10 Vegas there, so my net Vega exposure is -3 because I'm short 13 and I'm long 10.

By being short three Vega, I am going to have some negative volatility exposure. Remember that when the market rises, volatility typically goes down. So look at how well you can strategically play, you know, the market or Starbucks in this specific instance, by setting up a short put spread in that if you are correct and the stock rallies—because you're positive Delta; you want the stock to move higher—then you're probably going to see the implied volatility of Starbucks go down because most stocks do follow that relationship.

Volatility is its own metric. Some stocks, when the price rises, the volatility also rises, and when the price goes down, the volatility goes down; that does happen too. But most individual stocks are going to follow suit with the overall market where you have the inverse relationship between volatility and price.

So, by choosing something like a short put spread, you're able to capitalize on any volatility contraction that might happen in the marketplace, which could also be accompanied by the market rising—a stock going higher—which is going to be really, really good for your short put spread strategy. But an altogether different strategy that you could choose, that's very similar in a lot of ways but different in some significant ones, is you could just, you know, clear this away. Let's say you want to go into an undefined risk strategy that's going to be able to better capitalize on any volatility contractions.

So, maybe you go in and you just sell a 90 put. Now you can see this is still a bullish strategy, similar to the one we just had; it's even more bullish than the short put spread. But now you have a higher probability of making 50%, which makes sense because that's the general relationship between undefined risk and defined risk.

But now you're short 10 Vega; there's no long Vega, there's no defined risk. So, now you have more exposure to volatility contraction. Now, of course, it's been said before, "for every gimme, there's a gotcha," so you might be wondering, "R Jim, I've got this gimme of more Vega, I've got this gimme of more volatility exposure; where is the gotcha?

" Well, what happens if Starbucks goes down? You're going to get hurt more than you would with that short put spread. Of course, it's games and gotchas; you know, it's pros and cons, it's trade-offs; it's always trade-offs.

You could make your whole career, your whole investing life, just selling puts from start to finish. I know many traders who have done that and have been really, really successful. You've got positive drift, you've got negative Vega; you have so many things that are working for you that are in your favor.

So, there's a couple of examples of what you can do with short volatility trades, and of course, there are so many other things that you can do. I mean, the permutations and combinations that are available in the world of options, even just on the short side alone, are almost literally endless. So, use this as a starting point to uncover additional short premium trades that you can begin to add to your portfolio.

Now, of course, there might be some times when you want to play a debit strategy, maybe play for a volatility spike. So, let's hop back into TastyTrade now and work through how to set those up as well. There are a million other things that you could do; I've only begun to scratch the surface, but I just kind of wanted to push you out of the nest with a couple of little examples and a couple of examples that will probably resonate with you if you're coming from a stock world, if you're coming from a long-term investing world where you like playing the market to the upside.

Well, short put spreads and short puts are going to do that just like we did on the short premium side. Let's set up a couple of long premium trades that would benefit from volatility expanding. So, let's go into the watch list here and go back to my watch list.

I've got Tasty Default, I'm going to sort my IV rank from low to high because now I'm looking for a low implied volatility opportunity to, you know, put on a debit strategy that's going to benefit from volatility expanding. Well, one thing that catches my eye here is QQQ; this is the NASDAQ index. You know, the IV rank is 27, so it's not super low; it is below 30 from that study.

But even though the study was more focused on, you know, short premium and selling premium strategies, still this is not a terrible opportunity for buying premium, and there aren't too many low volatility options right now. You've got the VIX at 20, you've got VIX futures at just over 20 as well, so there's just not a ton of low volatility opportunities in the marketplace right now. So, if I go into QQQ, a classic strategy to take advantage of volatility expansion is an at-the-money put vertical.

So, let's say you're bearish on the NASDAQ and you want to position yourself to take advantage of volatility expansion. Well, what you could do— you’ve got the stock at 486 and some change— you could step in here, you could buy a 490 put and you could sell a 480 put. So, this is an at-the-money vertical.

You see the probability of profit is right around 50%. That's typically what we want with an at-the-money vertical. This is usually a directional shot that you're taking in the stock, but.

. . From a volatility standpoint, the nice thing about using a long put vertical is that it does set you up with positive Vega.

It's not a ton; we want to make our money on the short volatility side of the market, but you do have a little something here where you're buying 66 Vega, selling 64 Vega, and you're going to be slightly net positive Vega. So, you do have a little bit of long Vega exposure, which is nice because you're also going to benefit. Like if I go to the curve view here, you can see I make money if QQQ goes down.

It's a bearish trade that makes perfect sense if the market prices are going down. Market volatility is oftentimes going up, and so this is a situation where I could get paid on the Delta from the market going down, but I also get paid a little kicker from volatility expanding because I'm positive Vega. So, this is one way to set up a positive Vega volatility expanding trade using just an equity index.

Of course, there are a number of different ways that you could do this. You can take this example, explore other stocks, other underlyings, and things like that. But one of the other strategies that is even more positive Vega is you could go in here and set up a calendar spread.

Again, you've got QQQ at 486, 487. Maybe you want to say, "Okay, I want to be neutral on the NASDAQ index; I don't really want a ton of directional exposure either way, at least not right now, but I want to play for some volatility expansion. " Well, again, focusing on this Vega that we see here on this little column on this dropdown, a calendar spread, of course, involves buying the back month and selling the front month at overlapping strikes.

So, here, I'm in November with 41 days to go; maybe I sell this 485 put, so I'm selling 66 Vega at the 485 put. I minimize November, I open up December, and I buy the same strike, the 485 put. So, the strategy is going to cost me $4, but look at the Vega impact that you're going to have on this strategy.

You're going to be long 20-plus Vega, so you are going to have a lot of positive volatility exposure. You can make the case, "Well, Jim, if volatility expands, you know the market may go down a lot more; it may not stay around 45. That would be bad for this strategy," and so on and so forth.

I would not necessarily argue with you, so maybe you want to adjust your strikes, maybe you want to move these things a bit lower. My purpose here was just to give you a couple of examples of how to trade volatility from both the short side and the long side. My overachievers out there, you all probably noticed how I just kind of glossed over, like, "Alright, let's say you're bullish on this stock; let's say you're bearish on that stock.

Let's not talk about how we arrived at that directional bias; let's just assume that it's there. " My overachievers are probably thinking, "Wait a minute, wait a minute, wait a minute! How did you come to that conclusion?

" Well, again, when it comes to day-to-day movements, I firmly believe it's all completely random. You can use the charts, you can use the balance sheets, you can use the whatevers to determine your own personal directional bias in that underlying stock. But if you want some guidance and reference points for your overall portfolio directional metrics, then I would encourage you to check out the portfolio management crash course that's already on the YouTube channel.

And if you sit tight for about 3 seconds, it's actually going to start right now.