Compare high and low implied volatility scenarios.

To put it simply: When IV is low, it’s easier to profit and your profits are higher (for buyers). When IV is high, it is harder to profit — and the profit is lower. Of course, it is visa-versa for option sellers.

Sometimes, however, higher IV is justified, mainly due to stock volatility/conditions or market conditions. For example: NFLX volatility is twice as high to WMT (when compared in percentage). We can also expect the IV and the options premium to reflect that.

An analogy could be done to the PE ratio. Most of the time, a company deserves a high or low PE ratio. But when it’s extreme, it is usually a contrarian sign.

So, how do we know if IV is high or low? AND more importantly: How do we know if the odds are in our favor?  By using IV Percentile (Rank)

IV Rank (percentile) is a measurement of stock IV. For example, if a stock has a IV Rank of 92.5%. This means that over the last 200 days, 92.5% of them had lower IV than the current one. Or simply put: The current IV is high.

These calculations have several characteristics:

  • There is fluctuation between 0-100
  • Reverting (after a high value, you can expect a lower value in higher probability)
  • If the IV rank is high, it is more favorable towards options selling.
  • If the IV rank is low, it is more favorable towards options buying.

Right now, we are in an interesting place; volatility, both real and implied, are trending higher. But, still well below peaks or panic levels, despite the relatively high level of overall uncertainty.

With elections, trade tariff talks, and crucial Fed meetings regarding interest rates, expect an increase in both realized and implied volatility levels. Knowing this will impact your positions., and help them become more profitable.

 



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