What Is Implied Volatility (IV) And Why It Matters In Options Trading?

Implied Volatility (IV) refers to the probability of the fluctuation in the market price of a stock, in short, it is a prediction of how volatile the stock can be at a certain point. The higher the IV, the more volatile in price movement the stock is expected to be.

A stock can have a high IV (which means more volatile) when it is approaching the earnings season as the probability of the share price going up or down is higher than the usual period. Stocks can also have high IV when the market is going through uncertainties, especially when the market is bearish (going down).

Why Does IV Matters In Options Trading?

IV matters because the higher the IV, the higher the premium for a given option contract. A high IV means the seller of the option contract (whether PUT or CALL) will have a higher risk of the contract not going his way and thus he will be compensated with a higher premium because of the higher risk involved.

Thus, if you are a seller of an option contract, you may want to consider selling an option contract when IV is high as you can command a higher premium. On the other hand, if you are a buyer of an option contract, you may want to buy when the IV is low.

A Tale Of 2 Tesla Option Contracts

I bought 2 Tesla LEAPS CALL with the same strike price, expiration date and delta on 31 Aug 21 and 15 Oct 21 respectively.

The share price of Tesla that I bought my LEAPS CALL on 31 Aug 21 was $738.18, while the share price of Tesla that I bought my LEAPS CALL on 15 Oct 21 was $839.70.

For that $100 increase in Tesla share price, by right, the premium should have increased by around $20 as the delta of the first CALL option contract was 0.194. However, I bought the 2nd option contract at almost the same premium price as the earlier one at $37.50.

This is due to the high IV for Tesla stock in August compared to the lower IV for Tesla stock in October. The fall in IV (or IV crush) swings the advantage to the buyer who can purchase at a lower premium for a similar contract with the same strike price, date of expiration and delta.

Conclusion
Sell an option (CALL/ PUT) when IV is high and buy an option (CALL/ PUT) when IV is low.

***
Keen to learn about options trading but do not wish to pay for expensive courses, this newbie guide will help gain the knowledge and fundamentals to understand options better. And it’s totally free!
The Newbie’s Guide To Options Trading

The LEAPS Strategy has helped me make more than USD120,000 in 2021. Here’s all you need to know about this strategy that can help you increase your wealth exponentially:
The Ultimate LEAPS Options Thread

Looking for ideas on what stocks to invest in or which stocks to trade? You can take reference from what I have been buying or selling. I try to update them as soon as I can in this section, as well as share my thoughts behind executing these trades:
MY TRADES

Excited to start your trading journey or perhaps try out with a paper trading account to build your confidence in trading? Check out this step-by-step to help you get started:
How To Buy Options on Interactive Brokers (Step-By-Step)

I watched tons of videos on YouTube since 2020 and if you are wondering if there are any useful channels that you can subscribe to for learning market trends, TA, FA, check out this compilation here:
My Secret Weapons For Options Trading: I Watch These YouTube Financial Channels Every Day

I concluded my first year of options trading with more than USD160k of gain, see how I do it and the capital I use for every month to give you a sensing of the percentage yield I get out of my gains:
1st Year Options Trading Recap: The Journey Towards SGD$217,509 Profits In 2021

This blog is as authentic and as transparent as I can share, I do not just show the wins and hide the loss. I have made some very bad decisions in the first 8 years of investing and paid a huge price for them. Here is the loss I have accumulated during these years. I hope you learn some lessons from my mistakes.
I Cut $135,715 Worth Of Losses In The Last 1.5 Months

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s