Options Implied Volatility (IV)

[Kim]

I'm creating this topic to discuss one of the most important aspect of options trading - Implied Volatility.

 

We will discuss examples how IV impacts our trades. 

 

I welcome questions from members and forum guests (registration required).

[Richard]

Im really glad you created this topic Kim as IV is still a mysterious concept to me. How do you measure IV on an individual stock? Is it usually a readily available statistic or derived from the Greeks?

[Civicguy]

Me too. Love to know.

Eg why does it matter and why does it matter (or not) in the way SO trades

[Kim]

IV of individual stocks is set by market makers. Any options software like ONE will show it the IV, and your broker should show it as well.

 

I will provide few examples from our recent trades to demonstrate how IV impacts the trades. 

[Kim]

Lets take a look at SPX calendar trade we initiated on Dec. 04.

 

This is the initial P/L chart of the trade:

 

 

Now lets take a look at T+8 P/L chart - this is what the ONE software projected where we would be today:

 

 

With the current price of 2027, the trade would be down ~37%, all other factors equal.

 

However, take a look what happens if we adjust the IV by just 3 points:

 

 

Now take a look at the current P/L chart:

 

 

The trade is almost breakeven, despite the fact the SPX moved full 50 points from the strike!

 

This is a direct result of IV spike. If SPX moved up the same amount, the trade would be down probably 50%.

 

Of course this assume that we didn't adjust (we had to, this is part of our risk management plan, and the trade was closed for 7% loss). But in this case, understanding the impact of IV helps you to see that down moves in calendars are not as destructive as up moves because the trade is vega positive, so IV spike which usually happens on the way down helps the trade a lot.

[samico]

Great example of the influence of vega in the trade Kim. 

 

And how it impact straddles/Strangles?

 

Thanks 

 

Rodrigo

[Kim]

Lets examine one of our straddle examples where IV spike had a significant impact.

 

On July 28, we entered EXPE straddle at $8.45, with options IV around 59%:

 

 

Take a look at the Greeks:

 

Theta: -$23.00 (2.8% per day)
Vega: $14.00

 

Fast forward 2 days later:

 

 

IV of the options jumped to 77%, and the trade was worth $10.50, up 24%.

 

Now, lets do a quick math. Vega $14 means that each 1% (one point) IV increase will increase the value of the trade by $14. IV increase by 18%, so the trade should be up by $252. However, we should reduce it by two days of negative theta ($14*2=$28), so the next result should be increase of $224. The actual result was $1050-845=$205. Close enough.

 

We closed the trade for 16% gain, but some members held a bit longer and booked 25-30% gain. 

 

Now lets see what happened 2 days later after they reported earnings.

 

 

Despite the stock moving 6%+, the trade would be down 26%. This is a direct result of IV collapse - IV of the options went down to 39%.

 

And this is exactly why holding through earnings is so risky. In this case the loss was actually not so high because there still was 14 days to expiration. With options expiring in few days, the loss can be 80-90% if the stock doesn't move.

 

This is why it is so important to pay attention to the Implied Volatility.

[Optrader]

Is there any strategy that can make money with IV expected to decrease and stock going to rally ?

[Kim]

You are looking for vega negative gamma positive strategy. Not aware of any.

[Optrader]

Ok, then how can we hedge against IV decreasing in a straddle when stock starts moving up. The delta gains sometimes  is not enough to compensate for IV decrease. 

May be it is better to close position entirely and wait for IV to decrease ? e.g in NKE and ORCL . Both are now a real IV risk .

[Kim]

This is always a risk. But if the stock moves enough, gamma gains will usually offset the vega losses.

[4REAL]

Hey Mukundaa,

If you expect IV to decrease and stocks going to rally
a play worth exploring is entering a SPY put bull spread

In fact is it like the TLT-SPY pair we already have, but just the SPY-leg

for instance short 200 strike and long 195 strike
credit you get is 142 (for Jan16 spread) 153 (for Feb20 spread)
Required margin is 500

maximum loss could be 500-142 (credit you get) = 358
exit target would be like TLT-SPY pair around -0.20
so if markets do rally profit could be around 100/ 120

downside is since this is a directional trade, you're not hedged if markets continue to tank.


Other play could be buying the VIX call calendar spread we already have
short Feb17 long March17 16 call  at lower price
 

[Optrader]

This is interesting alternative, but adds risk and cuts profits.

In the sense, what if stock market takes dive,  straddles can be huge winners , but this put spread will take away all those gains and hand me loss .

 

A good hedge is one which protects or minimizes from loss and let profits run.

 

I only need IV hedge. I dont want to take market risk of SPY for that .

 

How can we achieve that ?

By the way, we got out of NKE straddle which was good thing to take profits when things have become unstable.

[penguin]

In response to an earlier post, if calendar spreads are vega positive and gamma negative, would the inverse (sell longer maturity and long shorter maturity) be a vega negative and gamma positive trade?

[samico]

Kim, 

 

Regarding the price of the underlying.

 

How much does it impacts the trade? Meaning, it seems to me that putting a straddle in an underlying that is priced at, lets say, $100, seems more effective than in one which trades at $30, because the higher priced one can move between strikes faster considering an enter 7 days before the earnings, which would do good to a straddle position as i would be taking credit as it moves. 

 

So if i get a picture of an underlying that has consistently moving 4% (which in a bigger priced stock means moving at least  2 strikes) 7 days before earnings during last 4 cycles, seems to me that this would be a favorite for a straddle? And the opposite is valid for a calendar?

 

Or volatility "means everything" composing the options price and i shouldn´t bother about this?

 

Please give me your thoughts if you can. 

 

Thanks 

 

Rodrigo.

Edited December 13, 2014 by samico

[Kim]

In response to an earlier post, if calendar spreads are vega positive and gamma negative, would the inverse (sell longer maturity and long shorter maturity) be a vega negative and gamma positive trade?

Yes, but this structure is not practical for most retail traders due to huge margin requirements and low potential return on margin.

[Kim]

Kim, 

 

Regarding the price of the underlying.

 

How much does it impacts the trade? Meaning, it seems to me that putting a straddle in an underlying that is priced at, lets say, $100, seems more effective than in one which trades at $30, because the higher priced one can move between strikes faster considering an enter 7 days before the earnings, which would do good to a straddle position as i would be taking credit as it moves. 

 

So if i get a picture of an underlying that has consistently moving 4% (which in a bigger priced stock means moving at least  2 strikes) 7 days before earnings during last 4 cycles, seems to me that this would be a favorite for a straddle? And the opposite is valid for a calendar?

 

Or volatility "means everything" composing the options price and i shouldn´t bother about this?

 

Please give me your thoughts if you can. 

 

Thanks 

 

Rodrigo.

I don't think there is a difference, except for lower commissions costs for higher priced stocks. Consider stock that moves ~3%. On 100 straddle you would roll from 100 to 105 strike, and on 30 straddle you would roll from 30 to 32 strike. In terms of volatility impact, there should not be a difference either because vega on higher priced stocks will be higher (all other factors equal).

[samico]

Kim, 

 

REgarding volatility in calendars, i was seeing a presentation by optionslam, and the presenter suggested that when entering calendars, the long options expiration should be a farther month like 3 or 4 months ahead instead of next month, because the implied volatility in the long strike being that far from expiration, would suffer less impact than the next month options, which implied volatility is already high due to the event. 

 

What do you think about this?

 

Also in another topic, knowing that IV decrease can hurt the straddle, is it fair to say that in a high iv situation it would be better to wait for it to come down in order to put the trades in the event of a vix spike?

 

Rodrigo

Edited December 13, 2014 by samico

[Kim]

For our earnings calendars, I believe that the front month provide the best risk/reward, assuming that the calendar is still cheap.

 

For your second question - this is always a risk, and this is why I avoided playing ORCL and FDX last week. I prefer to miss a trade than risk IV collapse and significant loss. 

[Optrader]

Now that IV is going to come down and stocks rally. What is our strategy ? 

We cannot trade earnings straddles or calendars till IV settles down or we are at risk.

 

I believe the only limited profit strategy is to write some put spreads ?

 

If that is the case which put spread is best return and less risk ?

a put spread on SPY for sure  

OR a  put spread on individual stock ? AZO say jan month ?

OR a put spread on a earnings month for the stock ?  e.g say  AZO ?  march month ?

[4REAL]

Hey Kim,

 

What is your take on a box spread ?

 

eg SPY Jan16  +198 -206 call spread and Jan16 +198 - 190 put spread (priced around 5.50/5.60 debit)

 

Could this be a play worth exploring in this enviroment

or will this 4-leg spread also suffer if VIX dropes ?

 

Is the risk/ reward ratio good enough ?

 

thanks

CJ

[4REAL]

Hey Kim,

 

What is your take on this reverse iron butterfly ?

 

eg SPY Jan16  +198 -206 call spread and Jan16 +198 - 190 put spread (priced around 5.50/5.60 debit)

 

Could this be a play worth exploring in this enviroment

or will this 4-leg spread also suffer if VIX dropes ?

 

Is the risk/ reward ratio good enough ?

 

thanks

CJ

after giving it some thought :

Risk/reward ratio is not good

max loss is debit (would in this case be 550)

max gain could be 250 (800-550) at expiration

So no need to explore this

Edited December 16, 2014 by 4REAL

[Kim]

Now that IV is going to come down and stocks rally. What is our strategy ? 

We cannot trade earnings straddles or calendars till IV settles down or we are at risk.

 

I believe the only limited profit strategy is to write some put spreads ?

 

If that is the case which put spread is best return and less risk ?

a put spread on SPY for sure  

OR a  put spread on individual stock ? AZO say jan month ?

OR a put spread on a earnings month for the stock ?  e.g say  AZO ?  march month ?

We will check the potential trades case by case. There still will be plenty of opportunities.

[Optrader]

Does it always make sense to sell a  credit spread when IV is high ? 

 

OR when IV is low ?

 

In current environment when IV is high, if we try to sell a iron condor or credit  spread, the   credit received is  less than the credit received when IV is low ?

 

This is because the difference in prices of options is less when IV is high as the high IV spreads prices everywhere.

 

But in low IV, the far away prices are negligible, so the protection that you buy in the spread is less .

 

In another thread, you mentioned that  if IV is high, it can help pre earnings calendars when IV comes down .

Is this true ?

e.g the earnings calendar for say CMG ? is it currently low ? in high IV environment ? or say GOOG ? for january earnings ?

OR it will become more cheaper as IV comes down ?

[Yowster]

Does it always make sense to sell a  credit spread when IV is high ? 

 

OR when IV is low ?

 

In current environment when IV is high, if we try to sell a iron condor or credit  spread, the   credit received is  less than the credit received when IV is low ?

 

This is because the difference in prices of options is less when IV is high as the high IV spreads prices everywhere.

 

But in low IV, the far away prices are negligible, so the protection that you buy in the spread is less .

 

In another thread, you mentioned that  if IV is high, it can help pre earnings calendars when IV comes down .

Is this true ?

e.g the earnings calendar for say CMG ? is it currently low ? in high IV environment ? or say GOOG ? for january earnings ?

OR it will become more cheaper as IV comes down ?

The higher the IV of a stock's options, the more you should be able to collect for credit spreads.   For example, take two stocks who trade at prices close to one another but with one having a significantly higher IV than the other.  If you look at credit spreads with strikes the same percentage OTM and with the same width and expiration date, the stock with the higher IV will always have its credit spread at a higher price.  If you can find an example that contradicts this, I'd like to see it.

 

Regarding the comment about IV and its effect on our pre-earnings calendars - its not as simple as saying IV going up or IV going down.  There are two different IV's to be concerned with here, the IV of the short leg and the IV of the long leg (as well as the different effects of theta on the different legs).  So IV coming down in the short leg at a higher rate than IV coming down on the long leg will help a pre-earnings calendar.  But IV coming down in the long leg at a higher rate than the short leg will hurt such a trade.  So you always have to look at the two IV's in relation to one another - and we kind of do this when we look at historical data for good entry prices for these calendars as a percentage of the stock price.

[Optrader]

Thanks

I think iron condor is not the best strategy when iv is expected to come down and stocks to rally

I think we need to play directionally with put credit spread

I hate to trade directionally but that is the only way to trade when iv is going to come down and stock to rally

If iv is expected to stay high then its different story but that is hardly the case

Look today the oil stocks rallied

Iv started to come down

[luxmon]

Mukundaa,

 

One way to play the market you mention that has worked for me is with a broken wing put butterfly with the wide wing to the downside.  Make it wide enough so you take in an initial credit.  Then if market goes up you keep your credit, and if IV drops fast you can remove the trade early for a profit.  If it stays neutral and you hold close to expiration,you can really win when it's in the thorax of the butterfly.

 

Tim

[Optrader]

Hi Tim

This really seems to be the right strategy to play iv

I am familiar with this name

i may put this as early as tomorrow on some names.

I was looking for a delta neutral and low gamma and high vega

Do you put this atm or otm ?

I guess atm to capture max vega profit ?

Thanks

[luxmon]

I usually do them slightly OTM such that the initial credit is about 10% of the downside wing (for example, $1 credit on a $10 wide wing).  I put it on indexes and high dollar stocks like GOOG.  For risk management I exit at a max loss of 15% of capital at risk, and scale out at different profit targets (5, 10, 15%, etc).  I don't mind leaving a fraction of my original spreads closer to expiration if I've already taken some profit.

 

There are free webex videos at Sheridan Mentoring with more on the strategy.

 

Tim

[Yowster]

Tim,

 

I've done trades very similar to your broken wing butterfly, but slightly different - my broken butterfly does not have a wider wing farther OTM, but I have 2 lower wings with the same width as the upper wing (so in this case the butterfly is a +1/-3/+2 ratio instead of the typical +1/-2/+1).  You can also think of it a buying one vertical spread and financing it by selling two farther OTM vertical spreads.  Like yours, I open for a credit so I'll still make money if the stock moves in the opposite direction.  I believe the P&L at expiration and the reaction to IV changes for both of theses trades is very similar (although mine will have a few more contracts so commissions will be slightly higher).  What I've noticed with mine is that if the stock price is right around my short strike, I have to wait until close to expiration date to maximize profits or else I leave a lot of potential profit on the table.  I'm wondering which of the two trades performs better in this scenario where the stock price is near the lower strike???

[luxmon]

Yowster,

 

That is an interesting tweak.  I compared them using RUT spread Jan week 2 expiry so I had $5 wide strikes to play with.  It looks like with your method you can get slightly larger credit for the same risk when using the same short strike (1st and 2nd trades below).  However, when I pushed the credit spreads out further (3rd trade in the list) the credit diminishes rapidly, even if doubling the width.  I might try this in the future if it gives a larger credit for the same level of risk.  

[luxmon]

Check that - on the last scenario above I didn't move down the upper strike to be equidistant from the short as the lower strike is.  When I do that the credit is still reasonable and gives the trade more breathing room to the downside.  Will have to consider this in the future.  

[Optrader]

taking a look at SLB , one of the stocks mentioned in Jeff Augen book,

 

Looking at straddle history, typically straddle trades for 3% move. But given the IV hike in oil, the jan monthly straddle is trading at 7% almost double.

 

So in general the market IV hikes the straddle IV of earnings, but that does not necessarily mean stock will move more post earnings. 

So its important to buy straddle when IV is low.

 

Hopefully with stocks rallying the straddles on most of our regular earnings come down.

[Kim]

Looks like VIX at ~20 become a new normal. This is a good news for options sellers who can get higher credits when trading strategies like ICs.

[Amos]

On 12/12/2014 at 9:41 AM, SteadyOptions said:

Lets examine one of our straddle examples where IV spike had a significant impact.

 

On July 28, we entered EXPE straddle at $8.45, with options IV around 59%:

 

 

Take a look at the Greeks:

 

Theta: -$23.00 (2.8% per day)
Vega: $14.00

 

Fast forward 2 days later:

 

 

IV of the options jumped to 77%, and the trade was worth $10.50, up 24%.

 

Now, lets do a quick math. Vega $14 means that each 1% (one point) IV increase will increase the value of the trade by $14. IV increase by 18%, so the trade should be up by $252. However, we should reduce it by two days of negative theta ($14*2=$28), so the next result should be increase of $224. The actual result was $1050-845=$205. Close enough.

 

We closed the trade for 16% gain, but some members held a bit longer and booked 25-30% gain. 

 

Now lets see what happened 2 days later after they reported earnings.

 

 

Despite the stock moving 6%+, the trade would be down 26%. This is a direct result of IV collapse - IV of the options went down to 39%.

 

And this is exactly why holding through earnings is so risky. In this case the loss was actually not so high because there still was 14 days to expiration. With options expiring in few days, the loss can be 80-90% if the stock doesn't move.

 

This is why it is so important to pay attention to the Implied Volatility.

This is my first post and I am trying to wrap my head around a lot of the math involved with what everyone is doing around here.

Mr. Kim I do have a question.

In the above example, we have this shown " However, we should reduce it by two days of negative theta ($14*2=$28), so the next result should be increase of $224. "

In the bold text above where did you get the negative theta number of $14. I can't figure it out. The only way i have got close is using the above example supplied negative theta of -$23 . I just took the -23 and multiplied by 2 days =$46. Took $46 and subtracted it from $252 = $206  for the final result. Am I doing something wrong getting this number because I can not figure out where 14 is coming from for negative theta. Not sure if I am missing some formula. If anyone can chime in that would be great.

One last thing, does anyone have a pdf or some cheat sheet with all the math formula's used with examples. I appreciate in advice and help from the community and really look forward staying here as in my 2nd day of trial, I find the info valuable although overwhelming. This is coming from someone who traded futures and forex for a decade. That was actually simple compared to options but the attraction towards numbers instead of candlesticks just feels right and the true meaning of reading the tape.

Thanks again everyone for posts I am able to learn from and hopefully one day I can contribute to the community.

[Kim]

@AmosYou are absolutely right, it should be -23 not -14. Good catch. So the $206 (expected gain) was even closer to the actual result of $205.

 

We don't really need any cheat sheets since the software already provides all the data.

[Amos]

2 minutes ago, SteadyOptions said:

@AmosYou are absolutely right, it should be -23 not -14. Good catch. So the $206 (expected gain) was even closer to the actual result of $205.

 

We don't really need any cheat sheets since the software already provides all the data.

That makes me feel better knowing my simple math skills were ok.

Yeah my next debacle is understanding software as I am using TOS but have used Ninjatrader forever. I thought I was smart using automated trade management in Ninja when I figured it out. Now its back into the frying pan. Thanks again Mr. Kim for the fast response.

[Kim]

Understanding options software is part of the learning curve, but it's well worth the time in the long term.

 

You might also consider the ONE software, our members also have discounted prices - 

 

P.S. Kim is good enough, I'm a simple guy..

[Bruce411]

 

I am new with SteadyOptions and thought I would post my question on IV in this thread.  I have looked at Implied Volatility on charts from Optionistics.com, Optionsanalysis.com and the Implied Volatility lower panel study for a stock chart on Think or Swim.  It seems that the values between Optionistics and Optionsanalysis are fairly close to each other.  But on Think or Swim they differ by quite a bit!

I assume that Optionistics is the way to go.  But in the past (before I signed up with SteadyOptions) I thought I was fine with Think or Swim.  

Can anyone offer me some insight on this?

Thanks in advance,

Bruce

 

[Yowster]

@Bruce411I have not used every tool that you mentioned in your post.   Technically speaking, each strike for each expiration has its own IV.    However, in many IV quotes the tools take weighted averages (ATM strikes carry more weight) to come up with an IV for a given option expiration week.   Also, some charts (like at ivolatility.com) use weighted averages across multiple option expirations to come up with an overall IV for a stock across all options expirations.  That being said, each of the tools you reference is probably displaying a correct option IV - its just how they are looking at it (strike/expiration specific IV, weighted IV average of a given expiration, or weighted IV average across all expirations).

[Javier]

12 hours ago, Bruce411 said:

 

I am new with SteadyOptions and thought I would post my question on IV in this thread.  I have looked at Implied Volatility on charts from Optionistics.com, Optionsanalysis.com and the Implied Volatility lower panel study for a stock chart on Think or Swim.  It seems that the values between Optionistics and Optionsanalysis are fairly close to each other.  But on Think or Swim they differ by quite a bit!

I assume that Optionistics is the way to go.  But in the past (before I signed up with SteadyOptions) I thought I was fine with Think or Swim.  

Can anyone offer me some insight on this?

Thanks in advance,

Bruce

 

I have struggled for years with your same questions with absolutely no exit. I have not worked with Optio.... but you will find the same with any other sources you use.

My last decision was to look at these figures relatively, I mean they are good to compare within the same platform and see that AAA has a higher volatility than BBB in TOS, at least this comparison uses to be coherent ... and You have to know, let’s say what Youngster is using to split shares as high, medium and low volatility ones.

P.D. after all makes no much difference if Today IBM has an IV of 50 or 53 or 52,5. You should conclude that it’s high historically for IBM and will be high in any platform you take.

This is my personal view.

[kesh]

 

Hi! If you buy options based on IV then when you do you close your positions - when IV opposite values are reached or you check first the underlying stock chart and the option price? Thanks