Section 11 - Chapter 1 - Meaning of Volatility to a Technician

Section 11 - Chapter 1 - Meaning of Volatility to a Technician - Presented by Rohan Sharma - The CMT Coach - Chartered Market Technician CMT Level 1 Study Material - CMT Level 1 Chapter Wise Short Notes - CMT Level 1 Course Content - CMT Level 1 2025 Exam Syllabus Visit Site : www.learn.ptaindia.com and www.ptaindia.com

1. Chapter 1 – Meaning to Volatility to a Technician Next Section 11 – Volatility Analysis Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

2. Agenda The Meaning of Volatility to a Technician Definition of Volatility The Importance of Measuring Volatility Types of Volatility Volatility Skew This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

3. Relative Strength Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

4. The Meaning of Volatility to a Technician 📌 Key Facts About Volatility in Technical Analysis 1. Definition: Volatility refers to the degree of variation in price movements over a given period. Higher volatility means larger price swings, while lower volatility suggests more stable prices. 2. Measurement: o Absolute Volatility: Measured using standard deviation of price returns. o Relative Volatility: Compared to other securities or market indexes. 3. Indicators Used: o Bollinger Bands: Expands and contracts with volatility. o Average True Range (ATR): Measures the average range between high and low prices. o Historical Volatility (HV): Past price fluctuations over a set period. o Implied Volatility (IV): Future expected volatility derived from options pricing .

5. The Meaning of Volatility to a Technician 📌 Key Facts About Volatility in Technical Analysis 4 . Market Context: o High volatility is common in uncertain or news-driven markets. o Low volatility may signal a potential breakout or trend reversal. 5. Impact on Trading: o Higher volatility can mean greater risk and reward. o Lower volatility markets may favor range-bound strategies. 6. Volatility & Market Phases: o Rising volatility often precedes a trend reversal. o Decreasing volatility suggests trend continuation or consolidation.

6. The Meaning of Volatility to a Technician Quick Cheat Sheet for Volatility Analysis . Concept Explanation Interpretation Historical Volatility (HV) Measures past price fluctuations over time. Higher HV → More uncertainty; Lower HV → Stability. Implied Volatility (IV) Market’s expectation of future volatility from options prices. High IV → Fear or uncertainty; Low IV → Complacency. Bollinger Bands Expands when volatility rises, contracts when it falls. Price near upper band → Overbought; Near lower band → Oversold. Average True Range (ATR) Measures the range of price movement. Higher ATR → More trading opportunities; Lower ATR → Sideways market. Volatility Index (VIX) "Fear gauge" of the market, measures expected volatility. Rising VIX → Fear & uncertainty; Falling VIX → Confidence & stability. Breakout Trading & Volatility Large moves often follow low-volatility periods. Squeeze → Potential explosive breakout (long or short).

7. The Meaning of Volatility to a Technician Interpretation of Volatility for Traders • Trend Confirmation: o A rising trend with increasing volatility → Strong trend. o A rising trend with decreasing volatility → Weakening trend. • Breakout Signals: o Low volatility squeeze often leads to an explosive breakout. • Risk Management: o High volatility → Adjust position size to control risk. o Low volatility → Tighter stop-loss to avoid getting caught in small moves. • Strategy Adaptation: o High Volatility → Favor momentum, trend-following strategies. o Low Volatility → Favor range-bound, mean-reversion strategies.

8. The Importance of Measuring Volatility in Technical Analysis 📌 Why Volatility Matters in Trading & Investing 1. Risk Assessment: Helps traders gauge potential price fluctuations and adjust position sizes accordingly. 2. Market Conditions: Differentiates between trending and range-bound markets. 3. Trade Timing: Identifies periods of low volatility that may precede breakouts. 4. Strategy Selection: Determines whether to use trend-following or mean-reverting strategies. 5. Options Pricing: Directly impacts the pricing of options contracts via implied volatility (IV). 6. Psychological Indicator: High volatility often reflects fear, uncertainty, or speculation.

9. The Importance of Measuring Volatility in Technical Analysis 📌 How Volatility is Measured Metric Definition Trading Implication Historical Volatility (HV) Measures past price fluctuations. Higher HV → Riskier asset. Implied Volatility (IV) Market expectations of future volatility. High IV → Expensive options. Bollinger Bands Expands with volatility, contracts with stability. Tight bands → Potential breakout. Average True Range (ATR) Measures price range over a period. Higher ATR → Larger stop losses. Volatility Index (VIX) "Fear gauge," measures market sentiment. Rising VIX → Bearish sentiment.

10. The Importance of Measuring Volatility in Technical Analysis 📌 Volatility & Market Behavior Volatility Level Market Condition Best Trading Approach High Volatility Uncertain, news-driven, or speculative markets. Momentum trading, trend following. Low Volatility Stable, consolidating markets. Range trading, breakout anticipation. 🎯 Key Takeaways ✅ Volatility helps traders manage risk effectively. ✅ It acts as a signal for market breakouts and reversals. ✅ Measuring volatility ensures better strategy selection.

11. Types of Volatility: Historical vs. Implied Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

12. Types of Volatility: Historical vs. Implied 📌 Key Facts About Historical & Implied Volatility 1. Historical Volatility (HV) o Measures past price fluctuations over a specific period. o Based on actual market movements (backward-looking). o Calculated using standard deviation of past returns. o Helps assess past risk levels but does not predict future moves. 2. Implied Volatility (IV) o Represents the market’s expectations of future volatility. o Derived from options pricing models (e.g., Black-Scholes). o Higher IV indicates uncertainty or expected large price swings. o Lower IV suggests stability and lower risk expectations.

13. Types of Volatility: Historical vs. Implied 📌 Quick Cheat Sheet: Historical vs. Implied Volatility Factor Historical Volatility (HV) Implied Volatility (IV) Definition Measures past price fluctuations. Market’s forecast of future volatility. Calculation Standard deviation of past returns. Derived from options pricing models. Timeframe Backward-looking. Forward-looking. Market Impact Shows how volatile an asset has been. Affects options pricing & trading strategies. Interpretation Higher HV → Recent large price swings. Higher IV → Market expects volatility ahead. Usage in Trading Confirms past trends & risk levels. Helps predict future price moves & option premiums.

14. Types of Volatility: Historical vs. Implied 📌 Comparative Analysis: Historical vs. Implied Volatility Scenario HV Behavior IV Behavior Trading Implication Market Crash or Crisis Spikes due to sharp past declines. Surges as investors expect more downside. High IV → Expensive options (puts rise). Stable Markets Low HV due to small price swings. IV declines as uncertainty reduces. Low IV → Cheaper options. Earnings or Major News Events May remain low before the event. Spikes due to anticipated volatility. Traders use IV to position ahead of the event. Post-Event Reaction Adjusts based on actual price moves. Often drops sharply after news release (IV crush). Option sellers profit from IV crush.

15. Types of Volatility: Historical vs. Implied 📌 Interpretation of Volatility for Trading • High Historical Volatility → The asset has had large past price swings. • High Implied Volatility → The market expects uncertainty or large price moves ahead. • Low HV & High IV → Traders anticipate volatility (e.g., before earnings). • High HV & Low IV → Market might be underpricing future risk . 💡 Key Takeaways ✅ HV reflects past risk, while IV predicts future uncertainty. ✅ Options traders rely on IV to gauge market expectations. ✅ Mismatches between HV & IV create trading opportunities (e.g., volatility arbitrage).

16. Volatility Skew Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

17. Volatility Skewness 📌 Key Facts About Volatility Skew 1. Definition: Volatility skew refers to the difference in implied volatility (IV) between options with different strike prices or expiration dates. 2. Why It Exists: o Market sentiment (fear vs. greed). o Demand for protective puts or speculative calls. o Historical price behavior (e.g., crashes tend to be more volatile). 3. Types of Skew: o Vertical Skew (Strike Price Skew): IV varies across different strike prices. o Horizontal Skew (Time Skew): IV varies across different expiration dates .

18. Volatility Skewness 📌 Key Facts About Volatility Skew 4 . Common Skew Patterns: o Put Skew (Smirk): IV is higher for OTM (Out of The Money) puts due to hedging demand. o Call Skew: IV is higher for OTM calls, often in commodities or high-growth stocks. o Forward Skew: IV increases with higher strikes (seen in bullish markets). o Reverse Skew: IV decreases with higher strikes (common in bearish markets). 5. Market Implications: o Skew helps traders assess risk appetite and market positioning. o A steep put skew signals fear and hedging demand. o A steep call skew suggests speculation on a major rally.

19. Volatility Skewness Volatility Skew Cheat Sheet Skew Type Description Interpretation Put Skew (Smirk) Higher IV for OTM puts than calls. Common in equities (investors hedge with puts). Call Skew Higher IV for OTM calls than puts. Seen in commodities & speculative stocks. Forward Skew IV increases with higher strike prices. Bullish sentiment, expected price spikes. Reverse Skew IV decreases with higher strike prices. Bearish sentiment, downside risk focus. Time Skew IV differs across expiration dates. Short-term events (earnings, news) increase IV in near-term options.

20. Volatility Skewness 📌 Volatility Skew Comparison Factor Put Skew (Equities) Call Skew (Commodities) Time Skew Common In Stocks, indices Oil, gold, growth stocks Pre-earnings or event-driven trades IV Behavior OTM puts have high IV OTM calls have high IV Near-term options have higher IV Market Sentiment Fear & downside hedging Bullish speculation Expected short-term volatility Trading Strategy Sell OTM puts (if expecting mean reversion) Sell OTM calls (if overhyped) Trade IV crush post-event

21. Volatility Skewness 📌 Interpretation of Volatility Skew for Trading • Put Skew → Fear & Downside Protection o High IV in OTM puts means investors are hedging downside risk. o Can be an opportunity for selling expensive puts if downside is overestimated. • Call Skew → Speculation & Demand for Upside o Higher IV in OTM calls signals bullish bets. o Useful for call spread strategies to take advantage of IV discrepancies. • Time Skew → Earnings & Event Risk o Higher IV in near-term options suggests a big move is expected. o Selling options post-event can take advantage of "IV crush." 💡 Key Takeaways ✅ Volatility skew reveals market sentiment (fear vs. greed). ✅ Traders use skew to identify mispriced options and potential IV drops. ✅ Understanding skew helps in structuring trades (e.g., credit spreads, hedging).

22. Trading Strategies Using Volatility Skew 🎯 Strategy 1: Selling Expensive Puts in a Put Skew (Risk Reversal Strategy) Scenario: • Stock XYZ is trading at $100. • Implied volatility (IV) is much higher for OTM puts than for OTM calls (classic put skew). • Traders are fearful, hedging with puts, causing them to be overpriced. Trade Setup: • Sell OTM Put (e.g., $90 strike put) → Collect premium from high IV. • Buy OTM Call (e.g., $110 strike call) → Take advantage of cheaper call IV. Why It Works: ✅ If the stock stays flat or rises, you profit from put decay and call appreciation. ✅ If volatility normalizes, put IV drops, making the short put position profitable. ✅ You have limited downside risk compared to outright stock ownership. Risk: If the stock drops significantly, you could be assigned on the short put. However, the long call can offset some losses .

23. Trading Strategies Using Volatility Skew 🎯 Strategy 2: Trading an Earnings IV Crush (Time Skew Play) Scenario: • Stock XYZ has earnings next week. • Near-term options (expiring next Friday) have an IV of 80%. • Options expiring a month later have an IV of 40%. • IV is expected to drop after earnings (IV crush). Trade Setup: • Sell a Straddle (ATM Call & Put) or an Iron Condor on near-term options before earnings. • Buy longer-dated options to hedge against unexpected moves. Why It Works: ✅ After earnings, IV collapses, making short-term options lose value quickly. ✅ If the stock doesn’t move much, you keep most of the premium collected. Risk: • If the stock moves massively, the straddle may lose money. • A hedge using long-term options can reduce risk.

24. Trading Strategies Using Volatility Skew 🎯 Strategy 3: Using Call Skew in Commodities (Covered Call or Vertical Spreads) Scenario: • Gold is trading at $2,000, and IV is higher on OTM calls than puts (bullish speculation). Trade Setup: • Sell an OTM Call (e.g., $2,100 strike) & Buy an ATM Call (e.g., $2,000 strike) → Bear Call Spread • OR Sell an OTM Call against long gold holdings (Covered Call). Why It Works: ✅ You capitalize on expensive call IV while limiting risk. ✅ In a mean-reverting market, overpriced calls tend to lose value. Risk: If the underlying asset rallies, your upside is capped . 💡 Key Takeaways ✅ Selling expensive options in a skewed market can be profitable. ✅ Using spreads or risk reversals helps balance reward vs. risk. ✅ Earnings & event-driven skews present great IV crush opportunities .

25. Chapter 2 – Measuring Historical Volatility Next Section 11 – Volatility Analysis Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia