What is the most stable profit model in the options market? VRP (Volatility Risk Premium) may be one of the answers.
This indicator may seem simple (implied volatility minus realized volatility), but behind it lies the most basic rule of the game in the market: people always pay too high a premium for "panic."
Just as people who buy fire insurance always think that their house will catch fire, stock investors always think that the stock market will soar or plummet tomorrow. This collective anxiety makes option sellers the collectors of "panic tax".
For example, during the U.S. stock market circuit breaker in March 2020, the implied volatility of S&P 500 index options reached 85%, but the actual volatility was only 60%, and the VRP was as high as 25%. Those who calmly sold the panic, the premiums they harvested in one month were equivalent to the income of half a year in normal times.
Practical posture of harvesting VRP
Primary gameplay: Build your "panic tax" assembly line
Sell call + put options (straddle combination) near the at-the-money level, and buy deep out-of-the-money put options as "insurance". For example, when the S&P 500 index is 4,000 points, sell a straddle combination with a strike price of 4,000, and then buy a put option with a strike price of 3,400.
The logic of this combination is to use out-of-the-money options to cover the most extreme black swans (such as a 15% market crash), while the volatility premium in the middle segment is firmly pocketed. This is like running a casino - allowing someone to win the jackpot occasionally, but the probability of making a steady profit in the long run is poor.
Advanced Play: Volatility Timing
When VRP soars (such as before the earnings season, when geopolitical conflicts are brewing), the market is like a frightened bird. Selling a straddle at this time is equivalent to selling a "lifebuoy" at a high price when the crowd is most panicked.
Before Nvidia's 2023 financial report, the implied volatility of options was 40% higher than the actual value. Later, it was proved that the stock price fluctuation was far less than expected, and the seller earned 30% of the premium in two days.
Avoid those pitfalls: The Dark Forest Law of VRP trading
Trap 1: Treating VRP as a perpetual motion machine
Many people thought that as long as the VRP was positive, they could sell options without thinking, but they encountered the flash crash of the pound in September 2022 - the implied volatility doubled in one day, and the actual volatility directly broke through all models.
The solution is to always keep an "escape route". My habit is to hold no more than 10% of the total funds, and must be accompanied by protective options with at least 10% out-of-the-money. Just like wearing a safety rope when walking on a tightrope at high altitude, you can perform boldly, but you won't fall to your death.
Trap 2: Obsession with short-term volatility forecasts
Trying to predict whether IV or RV will be higher or lower tomorrow is essentially like flipping a coin. The people who really make money do only one thing: focus on the long-term statistical advantage.
The data doesn't lie. Over the past 20 years, the probability of S&P 500 options VRP being positive has exceeded 70%, bringing an average excess return of 0.8% per month. This is equivalent to the market giving you a "panic red envelope" for free every year. All you have to do is reach out and catch it, rather than guessing how much money is in the red envelope.
From Bronze to King: Three Stages of VRP Thinking
Learn to see through the lies of volatility
Don’t be scared by the news of “volatility surge” anymore. Open your trading software and overlay the IV and RV curves together - when the two lines diverge, it’s time for you to enter the market and reap the rewards.
Using hedging to resolve human greed
Many novices sell put options naked with full positions, and when they encounter a 7% plunge in a single day, they are directly liquidated. Now every transaction of mine carries the "hedging gene": selling at-the-money options to earn premiums, and buying out-of-the-money options to prevent crashes. It's like carrying both a spear and a shield on the battlefield, and controlling the rhythm of attack and defense yourself.
Turning VRP into a volatility arbitrage network
The real top players have already jumped out of a single market. For example, in the third quarter of last year, a trader found that the VRP of crude oil options fell to negative numbers, while the VRP of US stocks was still high, so he immediately reduced his position in US stocks and turned to long crude oil volatility. Two months later, the conflict between Russia and Ukraine escalated, and the volatility of crude oil soared by 300%. This operation directly contributed 60% of the profits for the whole year.
In short, the market always rewards rational traders. The most fascinating thing about the VRP indicator is that it turns human weaknesses into quantifiable numbers. When others are screaming for ups and downs in front of the screen, you only need to calmly calculate the difference between the implied and the actual value - a 0.5% premium gap may be the difference between a novice and an expert.
Next time you trade, ask yourself this question: "Is the volatility pricing at this moment a bubble of panic or the result of rational evaluation?" If you figure out this question, you will find the key to sustained profitability.
