Volatility Arbitrage

Volatility arbitrage is a trading strategy that seeks to exploit the difference between an option's implied volatility (the market's expectation of future price movement, as priced into the option premium) and the trader's forecast of realised volatility (how much the underlying actually moves). If a trader believes the underlying will be more volatile than the option's current implied volatility suggests, they buy options (long volatility); if they believe the market is overestimating volatility, they sell options (short volatility), while hedging out the directional risk through delta hedging. Pure volatility arbitrage requires sophisticated modelling to forecast realised volatility accurately. In India, volatility arb strategies are primarily used by institutional options desks trading Nifty and Bank Nifty instruments.