Options Implied Volatility

Learning about options leads to learning about volatility – but, that is not easily understood. There are a lot of different volatility things out there. Volatility is the reason options become “over priced” and it is the reason there is skew inside the options chain. Signet has created a volatility school which explains volatility differences really well. You can find this volatility school at the https://bullishbears.com in the Next Level Library.

Here at the OEC Coaching Service – you can look at the blog posts that discuss various trade logic that uses Implied Volatility and learn how we use this to determine our hedges, to determine what to trade, what strikes to pick, and how much of the portfolio to allocate into the market. Below is a short list of some different volatility in options trading;

Implied Volatility on the options chain (with Skew)
Implied Volatility on the options series (with Expected Move)
Implied Volatility on the Daily chart
Implied Volatility within the Market Maker Move (MMM)

How does understanding this help us trade options effectively? The options trades we can take apply to the price of the underlying market (like a directional trade in $AAPL – we can buy an ATM call if we believe AAPL will go up within our DTE window), the options trades we can take apply to a change in volatility (like a volatility crush after earnings or like a spike in volatility during a global event such as when Russia invaded the Ukraine), and the options trades we can take apply to a change in time (like selling a put and buying it back after the extrinsic value has decreased from the decay in time). We can also pair things together to take options trades based on a belief that volatility will do something (like rise up) while also believing price will do something else (like not moving significantly up or down); a calendar trade would be a good choice for this type of trade logic.

In the picture above we are 47 days to expiration and are OTM significantly – we have built a 290 / 295 call credit spread trade that offers 0.45$ credit while risking 4.55$; this trade is on the edge of the expected move and is considered “high risk” due to that trade logic. Notice that this picture has an arrow pointing to the implied volatility column and shows us selling a lower volatility while buying a higher volatility?

In the picture above we are 47 days to expiration and are OTM significantly – we have built a 295/ 300 call credit spread trade that offers 1.40$ credit while risking 3.60$; this trade is just past the expected move and is considered a “lower risk” trade due to that trade logic; it also offers additional benefits; we have a trade farther away from the current market and we have a trade that is offering nearly 150% more credit and significantly less “max loss.” Notice that this picture has an arrow pointing to the implied volatility column and shows us selling a higher volatility while buying a lower volatility?

As you can see – implied volatility directly affects our trading decisions and our risk; implied volatility was used to calculate the expected move over the next 47 days while it was also used to price the call options; when we built the trade to work with the skew in our favor we had favorable results but when we did not focus on the options implied volatility our options spread price was much less favorable.

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Interested in learning more about implied volatility and how you could use it to trade options and options on futures more effectively? Reach out to Signet and request a free consultation for One on One coaching today!

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