Implied Volatility in context
IV does not mean much if it cannot be compared relative to some metric. This is why options traders often use IVR to check where it stands historically. Many traders who seek opportunities on stocks may want to scan the market using various tools on software platforms, or even the CBOE website.
For that purpose, IV is compared to its past values over a period of 6 months to a year. Brokers and options platforms may use one year data as a benchmark but at the end of the day, it remains at the trader’s discretion.
In a way, one can view IVR as a stochastic indicator of the IV data series therefore showing whether IV is “overbought” or “oversold”. This can easily be calculated on Excel for instance, using highest high and lowest low over the chosen period and then calculating the ratio. This is a standard metric among options trader yet IV is a time series, and for that matter, any preferred indicator could provide interesting information on its level and direction.
A low IV environment can then help select the appropriate Vega dependent strategy. The period in question will also determine the horizon going forward i.e. one can use one year for calendars, 6 months for flies and condors, and maybe 1 to 3 months for weeklies. Note that IV is generally available as daily data.
IV Percentile (IVP) requires a little bit more work as it is a statistical outcome of the IV distribution over the same period. We here need to count the number of days IV was in a particular range. This means one needs to chose a particular granularity or precision for this type of calculation.
A mean is generally not equal to the median number, so we should remain careful not to assume that a mean-reverting IV will necessarily move back to IV is most frequently sitting.
Choosing between IVR and IVP is a matter of personal choice and one generally sticks to what the options software offers and otherwise settle for the simplest: IVR.
It is a lot more important to remain consistent. Options trading is really a matter of discipline with the tools at hand.
Read more on the following page: IV Ranking
Check the Tasty Trade website from Tom Sosnoff & friends where good summaries can be found. Some stuff is really beginner level but there are interesting discussions also for the more advanced trader. Options trading means constant learning, doesn’t it ? 🙂