What is Volatility Trading?

Volatility is one of the most important forces driving opportunities in the financial markets. It measures the speed and magnitude of price fluctuations. Here is the general understanding of volatility

• When markets are calm, volatility is low, and prices move within a narrow range.
• When there is high uncertainty due to corporate earnings, elections, policy, or global shocks, volatility spikes.

In India, volatility is often tracked using the India VIX, a volatility index which is derived from NIFTY 50 options. For instance, during COVID-19, the market had crashed in 2020, and India's VIX shot over 80. This was the highest VIX level ever recorded, signalling extreme fear in the market.

Similarly, there is a high risk in VIX around Union Budget Announcements or the Lok Sabha elections. This also suggests that traders expect market turbulence. It is important to understand that while Vix is usually opposite to Nifty, this is not always the case, as can be seen from the chart below:

In India, volatility plays an extremely important role due to very frequent macro events (RBI policy announcements, Union Budgets, and elections). Global Fed interest rate decisions or oil price shocks also spill over into Indian markets, driving sudden turbulence. Clearly, understanding volatility is not optional—it's essential for survival in today's markets.

What is Volatility Trading?

Volatility trading is different from traditional trading. A regular trader usually bets on direction. Whether a stock or index will rise (go long) or fall (go short). But volatility traders don't care about direction. Instead, they care about magnitude. Will the markets move a lot? Or will it stay flat? If the market is expected to move sharply up or down, volatility traders use strategies that benefit from a big move in either direction, while if the market is going to remain quiet, they use strategies that benefit from a lack of volatility. Strategies that may help them profit from the time decay and low volatility.

For example, before the union budget, traders expect NIFTY to move sharply, but they might not know the direction. A volatility trader may buy a straddle (both a call and a put button) to profit either way. On the other hand, volatility is expected to drop after an event such as an election. So, traders may sell options to profit. They wait for the market before initiating the entry. Hence, volatility trading is less about “prediction” and more about the “positioning”.

Tools To Measure the Volatility in Indian Markets 

To succeed in the Indian markets in volatility trading, the volatility must be measured accurately first. Indian traders will use a mixture of measures to measure volatility: 

India VIX Volatility Index

These are based on the nifty options. It reflects the expected volatility expected to be reflected in the next 30 days. Usually, a low VIX (around 18) means the markets are calm, and a high VIX (above 25) indicates nervousness. 

Implied Volatility (IV)

It is derived from the option prices. The Black Scholes formula is used to calculate IV. If the IV is high, the options are expensive. It suggests that traders expect a big move. While options are expensive, they also give option buyers the chance of benefiting from quick moves.

Historical Volatility 

 It is used to measure past price fluctuations. This is calculated using OHLC of historical data. This measure shows the volatility of a particular scrip over the last 6 months to 1 year.

Average True Range (ATR)

ATR is a widely used technical indicator for intraday trading. It shows the average daily movement in stocks like HDFC Bank and ICICI Bank.

Together, all these tools will help traders decide whether the options offered are cheap or very expensive. 

Volatility Trading Strategies

Here are some popular trading strategies to capture volatility:

Long Straddle 

In this strategy, traders buy put and call options at the same strike price. They can earn profits from the market if there is a big move in either direction. For example, when buying a NIFTY 22000 straddle before the budget day. And if the market rallies considerably or drops sharply, the long straddle makes a profit.

Long Strangle

A “cheaper version” of a long straddle in which you can buy out-of-the-money call and put at different strike prices. It might be cheaper than a straddle but requires a bigger move to profit. Usually, this is more popular in BANKNIFTY since BANKNIFTY is much more volatile than Nifty. 

Event Trading 

This is a very popular strategy and is usually created ahead of corporate earnings, the RBI policy, or elections. Every company reports quarterly earnings, so event trading is extremely popular, allowing traders to take advantage of IV spikes. Usually, this includes buying a call and put option and exiting just before the earnings are announced. 

Mean Reversion

The opposite also works in event trading. As soon as the results are over, volatility may cool. So, option writers may sell both call and put options to profit. For example, after the Lok Sabha election results, volatility dropped significantly, allowing option sellers to benefit.

Using Options in Volatility Trading

In India, volatility trading is almost synonymous with option trading. Options give traders the flexibility to benefit from the movement itself. It rarely depends on the direction. Some ways in which options can be used to capture volatility are given below:

• Buying Options (Call/Put): Option buying is very useful when the conditions are uncertain and a decisive move is expected. For example, buying BANKNIFTY options before the RBI announcement can be a good strategy
• Selling options: Option writing is highly profitable when stability is expected. For example, many traders use weekly swing strategies, shorting calls and puts at the start of the expiry and exiting on expiry day, thereby taking profits from no volatility. 
• Spreads (Iron, Condor, Butterfly, Calendar spreads): Option selling can be very risky. So spreads can be used to limit the risks. Spread strategies are popular among the algorithm traders. Unlike stocks, options allow traders to construct risk and reward profiles based on their risk appetite and create spreads ideal for volatility play.

Risk Management In Volatility Trading

Volatility can be considered a double-edged sword. It may be able to generate the windfall profits. It may also lead to devastating losses. This is a reason why risk management is non-negotiable. Some important points to keep in mind before taking the entry:

• Position Sizing: One should never go all in. This is most applicable when India VIX is above 30, indicating high volatility.
• Stop-loss: Always have a clear stoploss in the system, especially for fast-moving indices such as BANKNIFTY, as the moves can be very quick.
• Hedging: Many traders who invest for an extended period are more inclined to buy puts. These will act as insurance during crashes while still giving the upside of stock moves. 

Case Studies From the Indian Markets 

• COVID-19 crash (2020): The Indian VIX reached over 80. The highest ever level. This indicates panic in the market. Many traders with long straddles earned massive gains. On the other hand, traders who sold naked options might have faced massive losses.
• Lok Sabha Elections (2024): Implied volatility increased in the run-up to the results. Once the results were announced, the uncertainty reduced and volatility dropped. This helped the traders who timed their trades well to earn profits. 
• Corporate Earnings Announcements often bring their own wave of turbulence.  TCS often sees a spike in implied volatility.  The Hinderberg report (2023) on Adani noted massive fluctuations in the Adani group's stock prices. Some short sellers earned massive profits because of the direction, but many volatility traders made a lot of money during the Adani group's fall.

These cases may help us understand that, even though volatility is risky, it can be very rewarding.

Common Pitfalls In Volatility Trading 

There are some common pitfalls of volatility trading that traders should avoid:

• Overleverage: Options offer massive leverage, but during periods of high volatility, this can backfire and lead to substantial losses. So leverage should be in check. 
• High IV = High Returns: Many traders feel that high IV means high returns. Always remember that high return expectations mean high risk. So trade carefully during high IV. 
• No Exit Plan: If you enter event trading without an exit plan and stop losses, it can be detrimental to your account. 
• Naked Selling: Option writing is highly profitable, but if you are selling naked options and they go against you, there can be massive losses. Always hedge or create a spread to reduce the impact. 

Conclusion 

Volatility is not to be feared. It is to be harnessed and understood. It might offer endless opportunities for all the traders, where you are an option buyer or writer. By understanding volatility, traders can profit from the market even without knowing the direction of the scrip. However, also focus on risk management as that is the key.