Now that my next generation option volatility model has a 60 to 70% accuracy in predicting the direction of volatility, what the heck do I do with it? I spent the last few days thinking about this because a trading model that has a slight edge doesn’t always mean profits. How do I translate this edge into a profitable option trading system and minimize risk?
I’ve been using the OptionsXpress virtual trading account to test out volatility strategies using straddles and strangles. I learned that short straddles and strangles don’t work very well even though my predicted volatility is supposed to go DOWN (I go long straddles/strangles with an UP prediction). A decrease in volatility sometimes means an increase in price, or vice versa. Besides short straddles/strangles leave you open to a whole lot of risk.
So let’s say I enter a short straddle (which makes me money if the market doesn’t move) because next week’s volatility is supposed to go down. I will still get burned if volatility goes down but the price goes up, which is a very likely outcome.
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