Decoding Volatility with the Rule of 16 | Teach Me Like I'm Five

In this episode of our new show Teach Me Like I'm 5, we’re joined by Mat Cashman, Principal of Investor Education at the OCC, to break down a powerful yet often overlooked concept in options trading: the Rule of 16. Whether you're new to volatility or a market veteran, this conversation takes you from the sandbox to the risk desk, explaining how this simple rule transforms annualized volatility into daily insight—and how professionals use it to assess market surprises, portfolio risk, and trading decisions.

What We Cover:

What the Rule of 16 is and why it matters

Translating annualized volatility into daily expectations

Why understanding standard deviation helps traders interpret large price moves

How experienced traders use the Rule of 16 to adjust to fast-changing volatility

Real-world examples including recent five-standard-deviation events

The psychological and behavioral impact of “surprising” moves on market participants

How to build a daily baseline for expected price movement

Using the Rule of 16 to contextualize options positions and risk management

Timestamps:
00:00 – “How surprised should you be if it rains?”
00:28 – Welcome and show introduction
01:06 – What is the Rule of 16?
02:08 – Why daily volatility matters more than annual volatility
03:17 – The Rule of 16 explained with a bouncy ball and sandwich
05:00 – Translating implied vol into daily expected movement
07:00 – Volatility as a weather forecast: what to expect, not what will happen
08:33 – How professionals use the Rule of 16
10:00 – Real-life example: 5.6 standard deviation move
12:00 – Crowd reaction and market psychology
13:00 – Adjusting to rising volatility and changing expectations
14:00 – Reaction functions for options traders
15:32 – Beyond the number: context, clues, and dynamic markets
16:52 – Wrap-up and final analogy