Volatility arbitrage is about trading volatility, not price movements. The goal? Profit from the difference between implied volatility (IV) (market expectations) and realised volatility (RV) (actual price movements). Here’s the gist:

• When IV is higher than RV: Sell options to capitalise on overpriced volatility.
• When IV is lower than RV: Buy options to benefit from undervalued volatility.
• Use a delta-neutral portfolio (balancing options and the underlying asset) to isolate volatility risk.

Key Points:

• Why it matters: Systematic trading strategies based on volatility can work even in flat markets.
• How it works: Focus on metrics like Delta (directional risk) and Vega (volatility sensitivity).
• Tools for Singapore traders: Platforms like SGX Titan and Interactive Brokers make it easier to trade options locally and globally.
• Risks: Watch out for sudden market moves, transaction costs, and frequent rebalancing needs.

Example:

A trader notices XYZ stock options with IV at 30% but expects RV to be 20%. They sell overpriced options, hedge with the stock, and profit when the market aligns with their RV prediction.

This strategy requires understanding options, managing risks, and using the right tools. Start small, focus on liquid assets, and keep refining your approach.

Implied vs Realised Volatility

Implied Volatility (IV) is essentially the market’s prediction of how much an asset’s price will fluctuate in the future. This forecast comes directly from current option prices – it’s like the market’s “price tag” for future volatility. On the flip side, Realised Volatility (RV) reflects the actual price movement of the asset over a specific time period, showing what actually happened.

When IV is higher than RV, options tend to be overpriced, making it an opportunity to sell volatility. Conversely, when IV is lower than expected RV, options are underpriced, creating a chance to buy volatility. Historical trends reveal that long volatility trades often succeed in over 60% of cases during major market events, while short volatility strategies see success rates of around 65–70% in calmer, post-event periods.

“Price is what you pay. Value is what you get.” – Macroption

Here’s a real-world example: In June 2024, a trader spotted XYZ Corp stock priced at $100. The 1-month at-the-money (ATM) call options had an IV of 30%, but the trader expected RV to be only 20%. Acting on this, they sold 10 call options, earning a $5,000 premium, and shorted 500 shares to maintain a delta-neutral position. By the end of the month, the stock’s actual movement aligned with the 20% forecast. The trader then bought back the options for $2,000, pocketing a net profit of $2,500 after $500 in transaction costs. This profit came from exploiting the 10% gap between IV and RV.

This example highlights the importance of understanding the next topic: option Greeks.

Key Option Greeks: Delta and Vega

Delta measures how much an option’s price changes with a $1 move in the underlying asset. It’s crucial for assessing directional risk, which traders must hedge. For call options, delta ranges between 0 and 1, while for put options, it ranges from –1 to 0. At-the-money options typically have a delta around 0.5 (calls) or –0.5 (puts). Since delta changes as the stock price or time shifts, traders need to rebalance frequently to maintain neutrality.

Vega, on the other hand, measures how much an option’s price changes with a 1% shift in implied volatility. In volatility arbitrage, vega becomes the main driver of profits. By hedging delta to achieve a net-zero position, traders isolate vega, relying entirely on the gap between actual and market-priced volatility for returns.

To calculate your hedge: Hedge Quantity = – (Net Delta × Lot Size).

Common Volatility Arbitrage Strategies

Once you understand volatility measures and option sensitivities, you can dive into specific trading strategies or explore systematic stock picks to build your portfolio.

Long volatility arbitrage involves buying options when IV is lower than the expected RV. Profits are made when actual price swings surpass market expectations. On the flip side, short volatility arbitrage entails selling options when IV is higher than the expected RV, earning premiums as the market moves less than anticipated. Both strategies require maintaining a delta-neutral position.

Another approach is gamma scalping, where traders actively adjust their hedge to capture small gains from price fluctuations. This strategy works particularly well with ATM options, which have the highest gamma sensitivity.

Lastly, relative value trades aim to exploit volatility differences across strike prices, expiration dates, or even between related instruments. For example, a trader might buy volatility in one instrument while selling it in another to take advantage of pricing inefficiencies across the volatility surface.

“In volatility arbitrage, volatility rather than price is used as the unit of relative measure, i.e. traders attempt to buy volatility when it is low and sell volatility when it is high.” – Wikipedia

Consider this example from September 2025: A trader executed a delta-neutral long straddle on the NIFTY index, which was at 25,200. They bought one 25,200 Call (Delta ≈ +0.49) at ₹215.4 and one 25,200 Put (Delta ≈ –0.50) at ₹265.35. With a lot size of 75, the maximum potential loss was ₹36,056. However, the profit potential was unlimited if the index moved sharply beyond the breakeven points of 24,719 or 25,681.

How to Start Volatility Arbitrage

Build Your Trading Foundation

To dive into volatility arbitrage, start by mastering the essentials of options trading. Focus on understanding the mechanics of options and key Greeks – Delta, Vega, Gamma, and Theta. These are your tools for managing a delta-neutral portfolio effectively. Make sure you’re also clear on the difference between implied volatility (IV) and realised volatility (RV), as these concepts are central to your strategy.

Set aside disposable capital and implement volatility-adjusted position sizing from the get-go. This is crucial because volatility arbitrage often requires frequent re-hedging, which can rack up transaction costs and eat into your profits.

“Position sizing is the glue that holds together a sound trading system”

When you’re starting out, stick to highly liquid assets like the S&P 500 or Nifty 50. These ensure smoother entries and exits when hedging your positions.

Set Up Your Tools and Data

Once you’ve got the basics down, it’s time to equip yourself with the right tools. Your trading platform or broker should offer robust options data and real-time tracking of the Greeks. You’ll also need access to historical price data (to calculate RV) and live options data (to determine IV).

Some key indicators to incorporate into your strategy include:

• Average True Range (ATR): Helps with position sizing.
• Bollinger Bands: Useful for spotting price expansions.
• VIX: Provides a snapshot of overall market sentiment.

Choose platforms that support automated order execution and allow you to set stop-losses. This can help you avoid emotional decision-making and stick to your strategy.

Calculate and Compare Volatility

To identify trading opportunities, you’ll need to calculate and compare RV and IV. For RV, use a 252-day sample of daily returns, which represents one full trading year. For IV, rely on pricing models like Black-Scholes to extract the data you need.

The comparison between IV and RV is where you find your edge. When IV is high, it might be a good time to sell. When IV is low, consider buying. Tools like IV Rank and ATR can help you fine-tune your positions. This step builds on your knowledge of options pricing and volatility concepts, setting the stage for effective arbitrage.

Basic Volatility Arbitrage Techniques

Delta Neutral Positions

Delta-neutral positions are a cornerstone of volatility arbitrage, allowing traders to focus purely on volatility movements while minimising directional risk through systematic approaches. Here’s how it works: you buy or sell options while simultaneously taking an offsetting position in the underlying asset – whether it’s a stock or a futures contract. This balance neutralises the impact of price direction, letting volatility drive your profits.

A common starting point is a long straddle, where you buy an at-the-money (ATM) call and an ATM put simultaneously. This naturally creates a close-to-zero net delta. However, as the underlying asset’s price moves, the option’s delta shifts due to gamma, requiring regular rebalancing to maintain neutrality. The hedge formula to calculate your adjustment is:

Hedge Quantity = – (Net Delta × Lot Size)

For example, if your net delta is +50 and the lot size is 100, you’d short 5,000 shares to maintain a delta-neutral position. Once this foundation is set, you can explore more advanced strategies like straddles and strangles, which build on the delta-neutral approach.

Long and Short Straddles/Strangles

Straddles and strangles are popular strategies for traders looking to profit from mismatches in volatility expectations. Here’s a quick breakdown:

• Straddle: Involves buying (or selling) a call and a put at the same strike price and expiration, typically ATM.
• Strangle: Uses out-of-the-money (OTM) options for both the call and put, which lowers the upfront cost but requires a larger price move to hit breakeven.

When to use them?

• Long straddles/strangles: Ideal when implied volatility (IV) is lower than the realised volatility (RV) you anticipate. These setups are often used before major events like earnings announcements or central bank meetings, where you expect a spike in volatility. For instance, in February 2024, a trader bought a US$600 straddle on NVIDIA for US$25 with IV at 80%. The stock was priced for a US$30 move but ended up moving US$38 after earnings, yielding a profit of US$13 per contract.
• Short straddles/strangles: These are used when IV is higher than the expected RV. For example, in March 2023, a trader sold a 395/400 call spread and a 380/375 put spread on the SPY ETF, collecting US$2.40 in premium. When the SPY closed at 390, the trader achieved maximum profit. Historically, short volatility strategies have a success rate of 65–70% during post-event periods when IV spikes briefly and then contracts.

Here’s a quick comparison of these strategies:

Beyond these approaches, traders can dive deeper into relative volatility strategies, which focus on pricing inefficiencies over time or between related assets.

Relative Volatility Trades

Relative volatility trades are another essential tool for systematic trading and volatility arbitrage, targeting inefficiencies in the volatility term structure. A straightforward way to start is with a calendar spread, which involves buying a longer-dated option and selling a shorter-dated option at the same strike price. This strategy profits from an increase in IV over time.

For example, in October 2023, ahead of an iPhone launch, a trader executed a calendar spread by buying an October 150 call on Apple and selling a September 150 call. The stock remained flat, but the rise in IV generated profit through vega expansion.

To identify such opportunities, keep an eye on the volatility term structure. If near-term volatility is significantly higher than long-term volatility, creating an inverted curve, it could signal a mean-reversion opportunity. Another advanced technique is dispersion trading, which takes advantage of volatility differences between an index and its components. By tracking correlation coefficients, traders can spot when the index’s IV deviates from the weighted average IV of its individual stocks.

Additionally, an IV Rank above 70–80 indicates that current volatility is elevated compared to its yearly range, which can present setups for short volatility trades. These methods offer traders a variety of ways to capitalise on volatility dynamics across different timeframes and asset relationships.

Risk Management and Systematic Execution

Managing Key Risks

Statistical arbitrage requires a disciplined approach to forecasting, but it comes with its share of risks. One major concern is sudden vega spikes, which can wreak havoc on short volatility positions. A stark reminder of this is the collapse of Long Term Capital Management (LTCM) during the Russian Financial Crisis in 1998 – a cautionary tale for traders operating in volatile environments.

Another significant risk is gamma and gap risk. Large, unexpected price jumps can disrupt a delta hedge, especially if they occur when you’re not actively monitoring your positions. To counter this, it’s crucial to set strict position sizing limits, ensuring no single trade dominates your portfolio. Tools like a high IV Rank can serve as early warning signals, helping you identify periods of unusually high volatility.

Addressing these risks underscores the importance of adhering to strict trading rules.

Creating Trading Rules

Once you’ve identified the key risks, the next step is to establish clear trading rules to mitigate them. A common approach is to buy volatility when implied volatility (IV) is below the forecast realised volatility (RV) and sell when IV exceeds forecast RV. However, narrow profit margins can quickly evaporate due to transaction costs. As Leo Smigel, Founder of Analyzing Alpha, aptly points out:

“Frequent rebalancing incurs high transaction fees. On the other hand, if a trader only rebalances periodically, it might result in an imperfect hedge”.

To manage this, set specific rebalancing triggers for delta adjustments, activating only when deviations cross predetermined thresholds. Limit orders for both entries and exits can help minimise slippage. For position sizing, the Average True Range (ATR) method is a practical tool. For example, lower ATR values may support higher leverage, while higher ATR readings call for a more cautious approach. Additionally, consider time-based exits, as prolonged inactivity in expected volatility can lead to theta decay, eroding the value of long options.

Backtesting and Continuous Learning

Once your rules are in place and risks are accounted for, the next step is to validate your strategies through backtesting. This process should cover various market conditions and include all associated costs, such as commissions, slippage, and rebalancing expenses. Historical data shows that short volatility strategies have been successful about 65–70% of the time during temporary IV spikes. However, the losses during unfavourable periods can be significant.

Incorporate all costs into your backtests and consider using advanced models like GARCH for more accurate volatility forecasts. Monitoring key Greeks – Delta, Gamma, and Vega – during backtesting provides insights into how your portfolio might behave under stress. Keeping a detailed trading journal to document backtests and live trades is essential for continuous improvement. For those seeking structured guidance, the Collin Seow Trading Academy offers systematic trading programmes that focus on developing disciplined, rule-based strategies suitable for various market conditions.

Practical Tips for Singapore Traders

Accessing Markets and Products

For traders in Singapore, there are reliable platforms to explore volatility arbitrage. Locally, the SGX Titan Platforms offer derivatives trading, while international opportunities are available through IBKR SG’s “Volatility Lab”.

It’s important to note that options on SGX are classified as Specified Investment Products. This means traders must meet the CAR or CKA requirements to access them. Stick to brokers regulated by MAS, such as DBS Vickers, OCBC Securities, UOB Kay Hian, or IBKR SG, to ensure compliance and security.

To predicting volatility and gauge market sentiment, the CBOE Volatility Index (VIX) serves as a handy benchmark. A VIX reading above 30 signals high volatility, which could mean more trading opportunities. On the other hand, a range between 15 and 25 suggests calmer market conditions. For managing risk, consider using ATR-based stop-losses, set at 1.5 to 2 times the ATR, to size your positions effectively.

Having these tools and strategies in place can streamline your access to the markets and set you up for efficient trading.

Managing Time Zones and Trading Hours

Once you’ve secured reliable market access, the next hurdle is managing trading hours. Singapore’s time zone offers both challenges and opportunities. For instance, the US markets operate from 9:00 PM to 6:00 AM SGT, while the highly active London/New York overlap runs from 9:00 PM to 1:00 AM SGT. Interestingly, this overlap accounts for nearly 58% of forex trades.

To avoid late-night fatigue, automation is your best friend. Set stop-loss and take-profit orders directly on your trading platform, so you don’t need to monitor trades in real-time. Automated systems can also handle delta-hedging tasks while you rest. For active trading, focus on the London/Singapore overlap (4:00 PM to 1:00 AM SGT), where liquidity is at its peak.

Be mindful of Daylight Savings Time changes in the US and UK, which occur in March/April and October/November. These shifts can alter market hours relative to SGT, so using an international market hours calculator can help you stay on track.

Learning Through Structured Education

To complement systematic execution and risk management, formal education can sharpen your skills and consistency. As Andrew Prochnow, an analyst at Luckbox, wisely puts it:

“In volatile markets, fortune favours the prepared – those with a well‑defined approach to both risk and opportunity”.

For traders in Singapore, the Collin Seow Trading Academy provides structured programmes tailored to local needs. Their Systematic Trader Program, led by a Qualified Chartered Portfolio Manager (CPM), is a popular choice. They also offer a free webclass, Systematic Trading Profits, which introduces a three-phase growth system for mastering stock trading. This programme focuses on a 15-minute-a-day systematic approach, making it perfect for those juggling full-time jobs alongside trading.

When choosing a training programme, always verify the credentials of the provider. Some may not be licensed financial advisors regulated by MAS, so it’s crucial to do your due diligence.

Conclusion

Volatility arbitrage is all about trading the ups and downs of volatility itself, rather than betting on market direction. The key lies in taking advantage of the difference between implied and realised volatility. For instance, buying options when implied volatility is low and selling when it spikes allows you to profit from these gaps, rather than relying on price movements. This method lays the groundwork for a disciplined, rules-based trading strategy.

To succeed, you need to understand the fundamentals and execute with precision. A strong grasp of option Greeks like delta and vega is crucial, as these metrics help you manage risk and fine-tune your strategy. Regular rebalancing is also vital – it ensures that volatility, not market direction, remains your main focus. Unlike passive strategies, this approach requires active management. Interestingly, traders who consistently use stop-loss orders report a 65% drop in emotional reactions during market downturns. The difference between those who succeed and those who don’t often boils down to sticking to systematic trading vs. emotional trading and maintaining strong risk management practices.

That said, volatility arbitrage isn’t without risks. It demands a disciplined approach to managing those risks effectively.

If you’re looking to deepen your knowledge and build a strong foundation, Collin Seow Trading Academy offers a wealth of resources, including training courses, webinars, and free materials.

Start small, refine your skills, and let systematic rules drive your decisions. Whether you’re using tools like ATR-based position sizing or automated delta hedging, the goal is to keep emotions out of the equation. By mastering these principles, you align your trading with a structured and disciplined framework. In the end, the markets reward preparation and strategy – not guesswork.

FAQs

What are the main risks to consider in volatility arbitrage?

Volatility arbitrage comes with a set of risks that traders need to approach with caution. One of the biggest challenges is misjudging realised volatility. If your predictions don’t align with actual market movements, the outcome can be unexpected losses.

Another hurdle lies in the need for constant delta-hedging, which can pile up costs through execution fees and slippage. Over time, these costs can eat into potential profits, making the strategy less effective.

There’s also the risk of the spread between implied and realised volatility behaving unpredictably. Even if your trade initially looks promising, unexpected shifts in this spread can turn things around quickly, leading to losses. To navigate these risks, it’s essential to deeply understand how volatility works and stick to a disciplined, systematic risk management plan.

What is a delta-neutral portfolio in volatility arbitrage, and how does it work?

A delta-neutral portfolio in volatility arbitrage is all about balance. Traders pair an option position with an opposing position in the underlying asset, ensuring the portfolio’s overall delta equals zero. This setup reduces directional risk, letting traders zero in on potential profits from the difference between the option’s implied volatility and the asset’s realised volatility.

By keeping this equilibrium, traders shield themselves from price swings in the underlying asset. Instead, they focus on shifts in volatility, which is the heart of the volatility arbitrage strategy.

What are the best tools for beginners in Singapore to start volatility arbitrage?

For those new to volatility arbitrage in Singapore, having the right tools can make the process far less overwhelming and much more structured. Here’s a breakdown of some essentials to get you started:

• Volatility indicators: Tools like the Average True Range (ATR), Bollinger Bands, and Donchian Channels are invaluable for pinpointing entry and exit points and keeping risk in check. For example, a 14-period ATR is handy for determining position sizes, while Bollinger Bands (set to a 20-period, 2σ) can signal when a market is overbought or oversold.
• Real-time charting platforms: Keeping up with market movements and indicator updates is crucial. Most brokers in Singapore offer trading platforms with built-in charting tools, making them a great option for beginners.
• Automation tools: Simplifying tasks like position sizing and setting stop-loss levels can reduce emotional decision-making and improve consistency. Even something as simple as a spreadsheet or basic scripts within your charting software can make a big difference.

By integrating these tools into your trading routine, you’ll be better equipped to create a systematic approach to volatility arbitrage while keeping your risks under control.