Volatility

Implied Volatility (IV)

IV Percentile or Rank

Low (< 50)
Medium (50-70)
High (71+)

High Volatility will often result in higher premiums for options. Many option strategies can utilize high volatility to their advantage to increase their returns (eg. higher premiums for Wheel Strategy).

IV Rank vs IV Percentile

These are often used interchangeably in casual conversation in option evaluation and trading but they are uniquely different.

IV Rank

(Current Implied Volatility - 52-Week IV Low) / (52-Week High - 52-Week Low)
(50.58% -21.6%) / (59.7% - 21.6%) = 28.98% / 38.1% = 76%
Volatility was lower 76% of the year; meaning volatility is moderately high as it has only been higher 24% of the year.

IV Percentile

# of Days Under the Current IV / #of Trading Days (252 for one year)
IVP tells you the percentage of time that the IV in the past has been lower than current IV.
It is a percentile number, so it varies between 0 and 100. A high IVP number, typically above 80, says that IV is high, and a low IVP, typically below 20, says that IV is low.
Notice that Think or Swim has listed IV Percentile at 76% when really that is really IV Rank.

Which one is better? Theoretically speaking, both showcase when premiums are typically higher and are much more reliable than just knowing the Implied Volatility of a stock.

So what do we do?

Use sites like barchart.com to find both the IV Rank and IV Percentile to select the appropriate strategy
The guide below focuses on various ranges, but the strategy sheet will look at anything as either >50 or <50
Assume that the higher the Percentile or Rank the higher your premiums
This is why we pay attention to volatility as it can let us when we should consider entries into the market

IV-Percentile-Guide.pdf

Implied Volatility Percentile or Rank

Below are the strategies you would employ with the following volatility

70-100th Percentile - High IV

Straddles, Strangles, Iron Butterfly

50-70th Percentile - Relatively High IV

Credit Spreads, Iron Condors, Broken Wing Butterflies

0-50th Percentile - Low IV

Debit Spread (Calls/Puts), Calendar Spread, Ratio Spread, Diagonals

Ultimate-Strategy-Guide-Option-Alpha.pdf

Strategy Guide Based on Direction and Volatility

Download

Click upper right hand corner to open > Download Document
You can click on the Table of Contents to jump to strategies
This guide focuses on High (>50%) or Low (<50%) to determine your strategy. Use the chart above to target the best strategy.

IV Rank or IV Percentile

High IV
- - Bullish Option Strategies - page 44
  - Neutral Strategies - page 62
  - Bearish Option Strategies - page 72
Low IV
- - Bullish Option Strategies - page 53
  - Neutral - Always Pass
  - Bearish Option Strategies - page 81

How does Volatility Impact Premiums

Calculating VEGA Impact

New Volatility - Old Volatility = Change in Volatility
Volatility Change x VEGA = VEGA Effect
Old Premium + VEGA Effect = New Premium

Example

For example, if the value of an option is 7.50, implied volatility is at 20 and the option has a Vega of 0.12
Assume that implied volatility moves from 20 to 21.5 (1.5 volatility increase).
The option price will increase by 1.5 x 0.12 = 0.18; from 7.50 + 0.18 = 7.68

IV Crush

IV Crush - when volatility is high and comes crashing down and decreases premiums

- Happens when a stock is moving quickly and everyone is buying or selling based on direction
- We learned that when Volatility is high option premiums increase
- If a stock does not make a large enough move to overcome volatility, your premium will drop significantly and in some cases it will be impossible to make a profit

Taking Advantage of IV

Catch the wave of volatility on the way up

- - Most common is the months leading up to earnings
  - Volatility increases and premiums extrinsic value increases

Sell on the Wave Down (Covered Calls) or Way Up (Cash Secured Puts) - see The Wheel Strategy

Covered Calls

- - - If you own the underlying stock, 100 shares or a LEAP, you can sell an option to collect premiums for promising to sell your shares at a defined price (Strike)
    - With volatility being high, extrinsic value increases the premium we collect
    - When volatility decreases, it takes a large portion of extrinsic value away (aka premium)
    - Generally you will want to avoid earnings
    - Use Support and Resistance to determine your strike prices

Cash Secured Puts

With Cash Secured Puts you are gaining the right to purchase shares at a lower predetermined price
This allows you to purchase shares at a cheaper price and collect premiums in the process

Volatility and Selling Calls/Puts

We buy when there is high volatility because we get higher premiums
When volatility falls, so will the value of the premiums
In both cases we want the options to expire OTM worthless
If they expire worthless, we keep the premium and nothing else happens. Sounds to good to be true right?

IV Facts

IV is typically the highest in the opening hour where price action moves quickly
IV is typically the highest when a stocks momentum is high and price action is moving quickly (bullish or bearish)
Higher IV means a larger premium to be paid (buyers) or collected (sellers)
SELL CALLS or PUTS when IV is at its highest to get a higher premium. Remember, reduced price action is your friend when you are selling calls as theta (time decay) is on your side.
BUY CALLS or PUTS when IV is low; momentum and price action will increase IV and premiums; be sure the stock's technical analysis support an upward movement.

Witching Week

High Volatility due to Market Sell Off of Options

March, June, September, and December
Third Friday of the month
These dates have a large number of options that expire on these dates
S&P (SPY), NASDAQ: Red days due to the large volume of selling
Funds that represent that represent the treasury and bonds are in direct opposition and will often go up.

Good reads on Volatility

IV Rank vs. IV Percentile: Which is Better?

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