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Volatility Offers A Clear Edge

Volatility Offers A Clear Edge

by The MoleApril 8, 2016

Yesterday’s post on volatility introduced you to the basic concept of realized volatility (RV) and how to interpret it in the context of your trading activities. We clearly demonstrated that volatility flows and ebbs in cycles which we can categorize into distinct volatility phases. On a short term basis trading volatility break outs seems tempting except that picking the direction can be tricky as many futures (and forex) contracts produce noisy candles ahead of trending moves.

Obviously the intent is to draw in suckers on both sides of the spectrum before picking a direction. Timing the best moment to hop on the bus is also tricky as volatility expansion may occur right away or several hours later. In a nutshell – it’s easy to get shaken out in the process which can quickly produce consecutive losers.


I know what you’re thinking – so how about using more longer term charts? Well, in theory yes, although it seems that volatility breakouts are harder to predict. What seems to work well however are volatility slow downs. My research shows that once volatility pushes beyond 1.5 standard deviations (plus/minus – it’s just a setting) odds strongly favor a slow down in the tape.

Leveraging Low Volatility

So how can we benefit form a drop in volatility? A pretty popular way to do it is to sell an iron condor, which is a four legged option credit spread. If you are unfamiliar with option strategies then don’t fret – we will cover the iron condor and other strategies in exhausting detail in the near future. For now all you need to know is that an iron condor benefits when prices do not move outside a defined price range. As such iron condor sellers love sideways choppy tape that doesn’t go anywhere. Heck, they must have made a fortune last year! 

The one problem with selling condors is that it’s tough to do on the futures or on forex. Yes options exist for both but having hosted a trading blog for the past eight years I know for a fact that most of you guys neither trade the futures nor forex and certainly not options tied to them. The average retail rat primarily focues on stocks, ETFs, and options. So let’s take a look at how the equivalent ETF looks like:


And that would be the Spiders which is tied against the S&P 500 cash index. Right from the get-go I really hate all those gaps. How is one supposed to properly evaluate volatility. And it seems that my DarthMole indicator (which measures volatility cycles) has a bit of a hard time with it. What do do?


Well fortunately I also had the weekly panel up and here it’s a completely different ballgame. I concede that the cycles show almost no frequency or amplitude whatsoever. BUT volatility slow downs on a weekly basis seem to be very predictable. So let’s try a few more:


And here are the cubes (an ETF running against the Nasdaq 100). I am counting seven occurrences where selling a condor would have worked, assuming we would have used weekly options. Which as a matter of fact is exactly what we’re going to be doing here, but again we’ll cover that later.


Of course the diamonds can’t be left out – the two last times turned into losers. So a good rule IMO is to not expect low volatility after high IV moves (when a snapback has good odds).



Here’s the IWM (running against the Russell 2000). Not sure if I would have ten the last one but seems to have very good odds for predicting volatility contractions.


GDX is a gold miners ETF – it seems to be begging for iron condors.

But we’re just getting warmed up… I’ll be adding links to the ETF specs below in case you don’t know the symbols:

XOP – very very juicy IMO – it actually is a mover but the yellow candles signal slow down almost every time.


USO – I think we all know that one – looking very good there. Only caveat, and that perhaps applies to the others as well, is that trying an IrCo during a strong trend is probably ill advised.


UNG – yummie yummie…


TLT – seems to work well despite general trendiness. I would however define a wider range as slow downs still seem to move up a little during a trend. However these are weekly options, so entering after a yellow candle and waiting one week should work brilliantly.


IYR – real estate also works like a charm 🙂


HYG – high yield corporate bonds and the only odd ETF out. As a matter of fact once it kicks into high gear it usually keeps on moving in the opposite direction of the yellow candle. So this one may be good for a directional play.


EWZ – those Brazilians not only seem to love waxing private parts and skimpy bikinis but iron condors as well. Who would have guessed?


EWJ – Japan goes three to two but the sample size is low. I’m undecided on this one as the Yen experiences a lot of manipulation.


EFA – eight winners and two losers, depending how you count it. For a weekly the fourth one on the left may actually have worked as the next candle does not reach far and precedes a big move. Not sure if I would have taken that one though. One of my rules would be that the yellow candle remains within a certain ATR range.


EEM – emerging markets also a clear winner in my book. The second one from the left may be counted as a loser depending on the range, so let’s call it four winners and one loser.

Bottom Line

Judging by a cursory review of the most popular ETFs it appears that selling condors in anticipation of volatility contractions has a high edge across a laundry list of market verticals. Thus iron condors will most definitely become part of our option trading arsenal going forward. Next week we will continue this series via a Forex volatility review and we’ll also pick up our option education series.


Now relax and enjoy your weekend, because clearly we’ll be very busy bees this spring. I’m very much looking forward to putting together some juicy volatility plays in the coming weeks. Prost!


About The Author
The Mole
Mole created Evil Speculator amidst the chaos of the financial crisis in early August of 2008. His vision for Evil Speculator is a refuge of reason, hands-on trading knowledge, and inspiration for traders of all ages and stripes. You can follow him and his nefarious schemes at the usual social media waterholes.
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  • http://gerb-reloaded.blogspot.com/ Gold_Gerb

    I went to a dentist that I didn’t like at all once.

    I just walked out of his office and Novocaine back.

  • ridingwaves

    speaking of volatility, picked up some TVIX on beat down…tide has changed…

    Volatility would be sweet in Bio sector as those phantom bid ask shake outs before move have gotten me many times…

  • mugabe

    A very interesting post on backtesting and the persistence or not of
    anomalies. Not aimed at short-term traders but I think the same principles apply.

    Dr. Hecht suggests that investors who look to backtests to inform their
    return expectations for the future may need to apply a “haircut.” That
    is, take the backtests with a grain of salt, and apply a discount. How
    big of a discount? Dr. Hecht suggests a 58% haircut to be conservative.


  • Grant

    Thank you for posting this. Looking forward to your roll out on how to use this.

  • ridingwaves

    gold is no longer available in 1100’s….
    it shows no signs of backing off….a big trigger about to be pulled….1600?

  • https://evilspeculator.com Sir Mole III

    Alright – I’m back – will finish the post now.

  • Yoda

    If yesterday’s low on DX is taken out, we may see acceleration. PM seem to pre-empt the move already.

  • Time Bandit

    FWIW, I have a very positive view and have experienced good results using back testing. Where back testing has flaws is while in test mode the assumptions are that all trades are taken and are taken with perfect execution. I’ve never been able to accomplish this type of perfection in live trading. However without back testing there would have been no starting point from where I could build a successful RBT.

    Another thing that happens is when back testing on paper, 4 or 5 losses in a row doesn’t hurt. But when having 4 or 5 losses in a row in live trading, the process becomes in doubt and is subject to over tweaking and abandonment. I’ve back tested, tweaked and abandoned many different methods. And in the vast majority of cases when I looked back in time after post abandonment, my original method would have worked.

  • ridingwaves

    NUGT heading for 79….setting up another wedge and decision point on the daily after exploding out of another 60 min wedge….I ment’d this back a couple threads…

  • mugabe

    My guess would be your live trading is in sync with your backtest because
    1) Your system is based on sound principles and not on datamining
    2) Your edge is not sufficiently well known/used for it to be arbitraged way
    3) You (possibly) haven’t hit the inevitable bad patch yet!

  • https://evilspeculator.com Sir Mole III

    Hey guys – reload the post and hold on to something as I am dropping the big one…

  • Time Bandit

    1) If “Sound Principles” means Price and only Price then the answer is yes.

    2) I only use varing lengths of Simple or Exponential BB’s and various ATR Multiples. Neither of these are anything new under the sun.

    3) From January 25th to February 10th, I experienced 9 Losses (5 Losses in a row) and 2 Wins. This might be considered a “Bad Patch”. The most important thing during this bad patch was that it followed an excellent patch and due to the results of my back testing this bad patch was not a surprise and was actually kind of expected.

    My system works best with Commodities. I’ve yet to develop a consistently good system that works with Equity Indices and I finally realized that I don’t need one because I don’t have to trade Equity Indices. 🙂 Individual stocks are too jiggy for my liking. Lastly, my system has tested out well with the few Futures (Once again Commodities) that I’m presently trading. Early expectations are that Futures will actually work better than my past real time results because of being able to avoid whipsaw type opening gaps. Time will tell how this works out.

    Oh I almost forgot, my longest time frame chart that I’m taking and managing trades from is a Daily and the shortest time frame chart that I’m taking and managing trades from is 30 Minutes.

  • mugabe

    By sound principles, I mean a system that hasn’t got loads of paramaters that are optimised (ie very unstable), and one that would still work if the existing few paramaters (e.g. the Boll Band) were adjusted up or down a bit. I also mean a system that isn’t based on some backtesting fluke that has happened to work in the past: eg go long crude at open on Tuesday and close position at close on Tuesday.
    It’s possible that the way you combine bolls and ATR is different from most people, or, at least, that it isn’t used by many people. By definition, if a sufficiently large critical mass of people were doing what you’re doing, the edge would get less and less.
    By a bad patch, I mean, say, a 30R drawdown. Let’s hope that doesn’t happen:)

  • wandering196

    Lots to think about for me, going to digest over the weekend

  • ridingwaves

    no kidding..

  • wandering196

    With my large screen computer

  • Time Bandit

    Is it possible to have a 30R drawdown? Well I guess anything is possible. One thing that I did was a 15 Year back test on /CL and didn’t even come close to a drawdown of that size. But that was using a Daily that I wont be using with Crude Futures because my Stop would have to be wider than I’m comfortable using right now. So I have kind of a new ballgame going on here with Crude. But the principle is the same.

    And at the risk of having my buddy call me an egotistical SOB again, after seeing thousands of charts, there is a thing called “Reading the Tape”. Now, I can’t read a tape for shit to make a decision on where I think the markets might be a month from now or next year. But I can read what the tape tells me right now. My parameters are very simple and I don’t like a chart that look like somebody puked up a plate of spaghetti on it.

    Kind of disagree with what you said about a statistically large amount of people doing what I’m doing and then having less of an edge. I believe most small traders won’t do what I’m doing because they either follow somebody else or trade on emotion and gut and get smoked. Besides, the amount of money that I try to take out of the markets doesn’t even amount to a tiny speck of flea shit compared to the monetary market transactions that take place every day. 🙂

    BTW, I always appreciate your questions because by writing this stuff down and exposing what I write to people who have a general idea of what I’m talking about, it forces me think and gives me clearity within my own mind of what I’m trying to accomplish.

  • mugabe

    Good exchange:)
    Is it possible to have a 30R drawdown? Yes.
    You might well be right about most small traders not doing what you’re doing because they’re not professional. The problem would/might be if some professional heavy hitters starting doing what you’re doing, possibly in an automated way.

  • Ronebadger

    I still think they should abolish cash.

  • mugabe

    Re info diet, this is quite relevant and funny:

  • Time Bandit

    I think we are close to being on the same page here but what I’m trying to do is to follow the “automation” that’s already in place not create anything new. Don’t forget, I’m basically a MOMO player so where price goes, I want to go. I suck at playing support and resistance so I’ll try to go with what I believe to be the least resistance. Does it work all the time? Hell no. But there’s the other side and IMO the most imortant part of any trade and that’s called trade managment. Once again, nothing new under the sun. Cut your losers short and let your winners run.

  • mugabe

    I think you’re selling yourself a bit short. You worked v hard to get your system(s) and, so far at least, in both backtesting and live trading, it seems to be a v good one.

  • ridingwaves

    damnation! 2 volume holes to glory…


    My off Friday, heading out w/ Family. Enjoy the weekend.

  • Time Bandit

    Thanks Mugabe. 🙂

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb
  • Time Bandit

    I never watched this series when it was on regular TV. But when I began watching it on Netflix, I became “addicted” to it. This is a great show.

  • strider

    Interesting stuff and I’m looking forward to seeing how this works out.

  • captainboom

    Not me. Ever read 1984? Loss of cash will lead to further intrusiveness by the state and/or large private corporations that have the wherewithal to track all your purchases and invade your privacy. Big data intrudes too much on my life as it is, and there are plenty of times I want to pay with cash for legal purchases, because it’s nobody’s damn business what I’m buying and when.

  • ridingwaves

    I agree and when cash is abolished lead might be a safehaven….

  • Ronebadger

    Read 1984…I just don’t like the “underground” economy

  • ridingwaves

    one of the best eva….

  • Billabong

    LOL …. It is soooo true.

  • Billabong

    It’s one of the few things left that truly allows you to be free … AU the other (no counter party risk).

  • Billabong

    Shorted YM 17523 using DXD with a tight SL.

  • almez

    Today we saw the opposite happen. Buying panic that fades. The zero has ticked negative currently, but without a big move, looks like people are on the sidelines

  • Billabong

    Depends on your system … I started getting a sell signal on NQ this afternoon and BABA gave a strong sell signal today (only the 4th time in a year). The real question is whether or not the sell signals will hold up through COB.

  • almez

    You mean the ticker BABA? Looking at price action it looks bearish. Good pick.

    I do agree things look bearish now. It also looks like there is an expedited FED meeting on rate hikes next week.

  • ridingwaves

    2025 target for end of day…

  • Billabong

    Yes … I trade equities and back tested commodity equivalent ETFs.

    I have to be honest, I don’t pick them my system identifies them as candidates. They work well in the direction of the market. I heard the FOMC was doing an out of cycle meeting. News is a double edged sword and good for a short period most of the time. With that said, the last 1/4 point raise was met with a sell-off…

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb
  • strider

    Abolish cash and go negative interest rate is government heaven.

  • Billabong

    I think it’s time for a short Miller…

  • ridingwaves

    fail on that one, that was some interesting action at the end…felt like one big distribution day

  • phantomflash

    Fantastic photo, Mole – I recognize the famous knife-edge northeast ridge of Capitol Peak in Colorado. A friend of mine has traversed that ridge (he was close to age 60 at the time) in the course of climbing all the Colorado “14-ers,” which he has now finished. I haven’t done Capitol, but I did climb another peak with him, and may again in the future.

  • http://gerb-reloaded.blogspot.com/ Gold_Gerb

    Weekend Oil Report Update from mid-February.

    I drink it up.

  • Grant

    Oceania has always been at war with East Asia….

    I’m their Huckleberry

  • mugabe

    Traders share the same stressors that entrepreneurs have and must manage the mind first before the money can really flow. A trader must continue to trade when the future is
    unknowable, this is in sharp contrast to the employee who gets paid consistently for their time. 90% of trading may be purely psychological AFTER you have developed your own systematic process for trading price action and have the right money management processes in place.
    Trading is not a perpetual money machine the profits and the income are irregular much like a salesman on commission.


  • Grant

    While I am not Buddhist, the need to understand the dynamics of risk taking and entrepreneurial effort paramount in life. The wage earner is no different except they place their trust in the company they are bonded too. If laid off, well counter party risk must be weighed. To succeed in entreprenial endeavors one must first count the cost. Meaning one’s budget must be lean or lean enough to survive the eventual pitfalls. All a part of discipline. It first starts with one’s world view and moves out from there.

  • mugabe

    Good quote from an email I was sent (can’t link it):

    The focus on the end-result of analysis rather than the analysis
    itself is precisely what is wrong with the way markets are analyzed
    these days. For many, the only “analysis” one does is to look at what
    appears after the equal sign (performance), rather than what comes
    before it (process).

  • TheRooster

    F**kin ace post mole. I fear very few here have realised that you have dropped a major edge in their laps judging by the comments which have largely ignored your post.

    What the hell is going on around here?

    One of my systems uses exactly the same vol contraction as a setup but i then use a breakout to trade the subsequent increase rather than playing expected vol decline – it has a low win rate of 38% due to the false breakouts you mention but an expectancy of 29%….

    I looked in depth at ICs a while back and what i saw was that if you trade them systematically you pick up pennies most months and then get creamed on any black swan events such as the flash crash….your way seems to put the odds back in the traders favour by taking fewer trades at more opportune times

    My problem is that i currently have no access to historical option prices for testing – what source/ platform do you use?

  • https://evilspeculator.com Sir Mole III

    That’s quite an accomplishment for 60. I climbed Teide the other week and realized that I’m a bit out of shape in the mountain goat department.

  • mugabe

    wow, not too shabby . 3,700 metres

  • https://evilspeculator.com Sir Mole III

    Does anyone else have trouble connecting to IQfeed this morning?

  • ridingwaves

    gold miners making parabolic like move now…..

  • https://evilspeculator.com Sir Mole III

    If it’s parabolic – when do you expect them to come back down? 😉


  • https://evilspeculator.com Sir Mole III
  • ridingwaves

    later today 🙂