Chapter 26: Sheldon Natenberg — Professional Options Trader
Core idea
Sheldon Natenberg’s central message reframes options trading: you are not just trading direction, you are trading speed. Every option has two dimensions you can bet on — where the stock is going and how fast it will move to get there. Most retail traders focus exclusively on direction. Most professionals focus on volatility. You can be right about direction and still lose if you bought when implied volatility was inflated, because the IV crush after the move can erase your delta gains.
Author’s argument: If you are truly good at picking direction, the simpler trade is just to buy or sell the stock. Options are the right instrument when you have an opinion on volatility — or when you want to express a directional view with a defined risk profile.
Direction is one of two trades
When you buy a call, you implicitly make two bets: the stock will rise (direction) and implied volatility will not collapse (speed). Professional traders treat these as separate trades. Retail traders usually conflate them.
Theoretical value vs. market price
Black-Scholes and similar models compute a theoretical value for an option given current inputs. The market price is set by supply and demand — and the difference, expressed as implied volatility, is the marketplace’s collective forecast of future movement. Professional edge often lives in that gap.
Why it matters
The biggest hidden tax on retail option traders is buying expensive volatility. Earnings season is the classic trap: a trader correctly predicts the direction of a stock’s move, holds calls into the announcement, the stock moves as predicted — and the calls lose money because implied volatility collapsed after the event. The Greeks (Chapter 23) tell you this can happen. Natenberg’s framing tells you why it dominates your P/L: volatility is the overriding consideration in options.
Implied volatility as crowd forecast
When IV is high, the market is collectively expecting big moves. When you buy at high IV, you are paying for that expectation in advance. The stock has to move more than the market already expects for you to profit on direction alone.
Key takeaways
Key takeaways
- Options trade two things at once: direction (where the stock is going) and speed (how fast it gets there).
- Implied volatility is the marketplace's collective forecast of future movement, embedded in the option price.
- Buying high-IV options means paying in advance for an expected move — the stock must outperform the expectation for the trade to win.
- Black-Scholes computes a theoretical value; comparing theoretical to market price reveals where the volatility edge sits.
- Most professional traders focus on volatility, not direction — direction trades are better expressed by buying or shorting the stock.
- Retail investors should combine a price outlook with a volatility awareness, not pick one in isolation.
Mental model
Read it as: Natenberg’s framework forces you to declare whether your edge is on direction or volatility. If your edge is purely directional, options add unnecessary friction — just trade the stock. If your edge is on volatility, options are the right tool. If you have neither edge, sit out.
Practical application
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Check IV percentile before every trade. Most brokerages display IV percentile or IV rank. Above 70 percent means IV is historically high (favor selling options); below 30 percent means IV is low (favor buying options).
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Separate your direction and volatility views. Before clicking buy, write down two sentences: “I expect the stock to do X” and “I expect implied volatility to do Y.” If you cannot fill in the second sentence, you are not really trading options.
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Avoid buying options before earnings. IV inflates into known events and collapses afterward. The directional move usually does not pay for the IV crush.
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Compare theoretical value to market price. Use a Black-Scholes calculator (the OIC and CBOE provide free ones) to compute fair value at your assumed inputs. Persistent deviations are where edges live.
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Consider selling, not buying, in high-IV environments. Credit spreads and iron condors profit from IV collapsing — they are explicitly volatility trades that pay you to take the other side of inflated expectations.
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Track your win/loss split by IV regime. If your buy-side directional trades lose disproportionately in high-IV regimes, that pattern is your tuition bill for ignoring volatility.
Example
Why a correct earnings call lost money
A trader expects a $100 stock to rally to $108 on earnings. They buy a 30-day $100 call for $5.50 the day before the announcement, when implied volatility sits at 80 percent. The stock pops to $108 the next morning — exactly as predicted. But implied volatility collapses from 80 to 35 percent now that the event has passed. The intrinsic value of the call is $8, but the option only trades at $8.20 — barely $0.20 of time value because IV crushed. The trader nets $2.70 per share ($8.20 minus $5.50), or about 49 percent. That sounds fine until you compare it to a simple stock purchase: 100 shares at $100 sold at $108 yielded $800 of profit on $10,000 of capital — an 8 percent gain. The option made more in percentage terms but on a $5,500 risk that could easily have gone to zero if the stock had not moved. Natenberg’s point lands here: if you have a strong directional view, the stock is often the cleaner trade. The option only wins big when both your direction and your volatility view are right.
Related lessons
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