James Richard Hill#51

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What is a volatility arbitrage strategy in forex and how does it work?

Volatility arbitrage exploits differences in implied volatility between options or between the spot market and derivatives. A typical example is when a trader notices that an options market overestimates future volatility compared to the actual volatility of the currency pair. By taking positions in both the options market and the underlying spot market, the trader can profit from the implied volatility difference. For example, if a forex option is priced for significant volatility, but the spot market is relatively calm, the trader might buy the option and sell the underlying currency pair, capturing the arbitrage opportunity. Institutions use volatility arbitrage as a core strategy in market-making and statistical arbitrage desks. Retail traders can apply similar tactics using implied volatility data from options markets, although execution costs and liquidity issues may limit their effectiveness. Volatility arbitrage helps institutional traders manage risk while profiting from price inefficiencies between spot and options markets.