As we primarily sell options, we prefer to sell expensive options, which equates to selling high Implied Volatility (IV).
We use IV rank to determine when IV is high compared to the underlying’s previous year of option prices.
IV Rank = (Current IV – Minimum IV) / (Maximum IV – Minimum IV)
The S&P 500’s volatility level is measured by the VIX. It currently sits around 12.25, with a max of 30 and a min of 10 relative to the past year. Plugging those numbers into the above formula ((12.25 -10) / (30-10)) yields an IVR for the SPY of 11%.
The IVR in SPY currently is 7.8%. Pitting that against the number that we got from our model, we can see that the IV is low- not so good for us!
So, we have to select our option strategies with IVR in mind. If the underlying displays high IV rank (usually above 50%), we like to use certain strategies that take advantage of that.
In high IVR environments, you get a larger average credit, which equates to larger profits overall. But you have to remember to diversify your portfolio, especially in elongated times of cheap IVR (like right now).
It’s smart to tailor trades to the current IVR environment, making sure to implement strategies that will be successful in the respective market atmosphere.
Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.
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