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Core Concept: Implied volatility (IV) is the market's expectation of future price movement, directly affecting option premiums.
Why It Matters
IV determines option prices independent of stock direction. High IV = expensive options, low IV = cheap options.
When to Use
✅ Use IV to:
- Time option purchases (buy low IV)
- Time option sales (sell high IV)
- Compare relative expensiveness
- Avoid pre-earnings buying
❌ Don't:
- Ignore IV rank/percentile
- Buy high IV expecting it to stay high
- Sell low IV options for income
IV vs Historical Volatility
Historical volatility (HV): Past realized price movement (fact)
Implied volatility (IV): Future expected movement (forecast)
IV can be above or below HV. Gap indicates market pricing in events (earnings, FDA approval, etc.).
Trade-offs
High IV: Expensive premiums (bad for buyers, good for sellers), mean reversion likely
Low IV: Cheap premiums (good for buyers, bad for sellers), can stay low long-term
IV connects to options_greeks through vega and affects intrinsic_extrinsic_value extrinsic component.
Quick Reference
IV Rank (IVR): Where current IV sits in 52-week range
Formula: (Current IV - 52-week Low) / (52-week High - 52-week Low) × 100
IV Percentile (IVP): Percentage of days in past year IV was lower
Example: 80 IVP = current IV higher than 80% of past year
| IV Rank | Strategy | Why |
|---|---|---|
| 0-25% | Buy options | Cheap premium, upside if IV rises |
| 25-50% | Neutral | Average pricing |
| 50-75% | Sell spreads | Elevated premium, benefit from IV contraction |
| 75-100% | Sell options | Expensive premium, collect high theta |
VIX (Volatility Index): Market-wide IV gauge (S&P 500 options)
- VIX < 15: Low volatility, complacency
- VIX 15-25: Normal range
- VIX > 25: Elevated fear, expensive options
Examples
Earnings IV crush:
Before earnings:
- Stock: $100
- ATM Call: $5.00
- IV: 80% (IVR: 95%)
After earnings (stock stays at $100):
- ATM Call: $2.00
- IV: 40% (IVR: 50%)
- Loss: $3.00 per share ($300 per contract) despite no price move
Lesson: High IV priced in the move. Even correct direction can lose money.
IV rank trading decision:
Stock A: IV = 30%, IVR = 20% (low)
→ Buy options (cheap, room for IV expansion)
Stock B: IV = 60%, IVR = 85% (high)
→ Sell options (expensive, IV likely to contract)
Volatility mean reversion:
Tech stock normal IV: 40%
Event spike:
- Day 1: News hits, IV jumps to 80%
- Day 5: No new news, IV at 70%
- Day 10: IV at 55%
- Day 30: IV back to 45%
Mean reversion made long options lose value even if stock went your direction.
Comparing strikes by IV:
Stock: $100, 30 DTE
| Strike | Premium | IV | Note |
|---|---|---|---|
| 95 Put | $2.00 | 35% | Normal IV |
| 90 Put | $1.50 | 45% | Volatility skew (higher) |
| 105 Call | $2.50 | 33% | Normal IV |
Lower strikes (puts) typically have higher IV due to crash risk (volatility skew). ```
References
- VIX Index
- "Volatility Trading" by Euan Sinclair
- Market Chameleon IV Tools