Overview
To an option trader engaging in volatility arbitrage, an option contract is a way to speculate in the volatility of the underlying rather than a directional bet on the underlier's price. If a trader buys options as part of a delta-neutral portfolio, he is said to be long volatility. If he sells options, he is said to be short volatility. So long as the trading is done delta-neutral, buying an option is a bet that the underlier's future realized volatility will be high, while selling an option is a bet that future realized volatility will be low. Because of the put–call parity, it doesn't matter if the options traded are calls or puts. This is true because put-call parity posits a risk neutral equivalence relationship between a call, a put and some amount of the underlier. Therefore, being long a delta-hedged call results in the same returns as being long a delta-hedged put.
Volatility arbitrage is not "true economic arbitrage" (in the sense of a risk free profit opportunity). It relies on predicting the future direction of implied volatility. Even portfolio based volatility arbitrage approaches which seek to "diversify" volatility risk can experience "black swan" events when changes in implied volatility are correlated across multiple securities and even markets. Long Term Capital Management used a volatility arbitrage approach.
Read more about this topic: Volatility Arbitrage