Volatility Mean Reversion

Volatility mean reversion is the observation that volatility tends to return to a long-term average level after periods of extreme spikes or unusual calm. This is a critical concept in options pricing, as the implied volatility of an option is a major component of its premium.

Traders who anticipate volatility mean reversion can profit by selling expensive options when volatility is high and buying them when volatility is low. This requires a deep understanding of the volatility term structure and the factors that drive market fear and greed.

It is a central component of volatility trading strategies, which focus on the variance of the asset rather than the direction of the price. It assumes that market fear is cyclical.