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Trading Lesson: Implied Volatility

January 23, 2015

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Implied Volatility (IV) is the hardest and most random thing to understand about the option. But when you have a good idea of what it is (high or low), that is the first step.
the second & most important step is “where the heck is it going to go??
Higher or lower from here
In Think or Swim, you can click add the IV symbol of the stock to a chart in the lower indicators and see the high and low of that IV range. Also take note of earnings date and how high that options vola goes to.

When there is high imp vola and no news or earnings coming soon, something is up. You can really get to have a feel of imp vola by doing the same strategy on paper or for real on a particular stock when its high IV and low IV.
A big time option trader said “there is historic vola of the stock, there is implied vola of the option, but there is actual vola of the option also. This refers to the speed of the IV changing. Some stocks have slow moving changes in the IV some have drastic quick changes. This greek is known as the “Vomma”. Yikes, more greeks! But yes Vomma is the sensitivity of the Vega.
Since implied vola is really past math numbers based on historic (past) volatility added with the specialists (market makers) fear of future movement and the big influence of supply and demand of the optins, it is almost impossible to predict.
That’s why I like to play options that are at extreme highs or lows, there fore I know its peaked or bottomed and can better guess which way it is going from here.
To put the odds in my favor when I notice lower than usual imp vola,
Implement a debit strategy, & when its high and no known events are near, then credit strategies.
You won’t nail it every time, but the odds in your favor are all you really are concerned about.
I recently have been doing short-term credit spreads with options 1 to 2 months out.
In a nutshell, notice how straddles and strangles don’t quit move enough lately to pay off?
Mainly since the vola drops like a rock right after earnings announcement.
I have been immediately doing bullputs on stocks that rise on the announcement about 2 to 3 strikes OTM and 2 to 3 days later the vola is gone and you can cash out. No need to wait till expiration, since time trades make you a slave to it and can burn you. And vice versa on drops.

You will notice not only patterns of strength & weakness of the stock, but also the patterns of imp vola of the options.
The stock is the candidate for which trend to play, the imp vola determines which strategy.
Gino

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2 Replies to “Trading Lesson: Implied Volatility”

  1. Edgardo Melendez says:

    Thanks for all this info Gino, will put to good use… Edgar M.

  2. Dave Kaufmann says:

    Great strategy Gino…I will practice it in coming weeks.

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