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IMPLIED VOLATILITY

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

EXAMPLE

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