Applying IV Rank to Strategy Selection
Jan 12, 2017
By: Sage Anderson
Trading volatility is much like any professional endeavor - continuously striving to find the optimal balance between risk and reward.
If you find yourself running late for a job interview, you’re forced to weigh the risk of getting a speeding ticket versus the potential reward of a new job offer.
Deploying capital involves the same type of decision-making, although typically over a longer time horizon.
In simple terms, this may translate to an understanding that buying the VIX on all-time highs, and selling it on all-time lows, may not be the most efficient method of capturing the highest possible returns.
Having said that, there may be instances where such trades are warranted - especially if they hedge correlated risk in your portfolio.
While the VIX can serve as an important guideline for managing portfolio risk, there are other indicators that traders can use to help signal potential opportunities.
The tastytrade metric known as Implied Volatility Rank (a.k.a IV Rank or IVR) is one such metric.
IV rank tells us whether implied volatility is high or low in a specific underlying based on the past year of IV data. For example, if XYZ has had an implied volatility (IV) between 30 and 60 over the past year and implied volatility is currently at 45, XYZ would have an IV Rank of 50%.
A recent episode of Options Jive focuses on IV Rank and explores how it can be used to identify trading strategies that may fit a variety of market conditions.
On the show, two charts are presented at the start of the episode that show the movement of both the VIX and and its corresponding IVR since the start of 2016, these help demonstrate the correlation between highs and lows in the two (i.e. when VIX is high, IVR is also high).
Hosts Tom Sosnoff and Tony Battista also breakdown the current IV Rank of the SPY.
With the VIX slumping to around 11 (historical average of roughly 19), it shouldn't come as a great surprise that IV Rank in the SPY is also presently low. IV Rank of SPY in early January 2017 was roughly 11, which is just slightly above its 1-year low of 10 (as compared to a 1-year high of 30).
The low IVR reading in SPY alongside a weak VIX seems to validate that premium sales in this underlying may not be optimal at current levels (depending on your current portfolio and approach).
Taking a step back, how then can IV Rank be used to identify potential opportunities across a range of market conditions? On this edition of Options Jive, Tom and Tony present and discuss some guidelines that can help traders uncover trading ideas using IVR as an indicator.
While we recommend you review the full episode for a comprehensive understanding of these topics, the graphic below summarizes that discussion:
As you can see from the above, low IVR conditions do not necessarily lend themselves well to premium selling opportunities. Instead, low IV may suggest that calendar spreads/debit spreads may be more appropriate.
Trades of this type will generally outperform when volatility expands, but reduce exposure to pure long volatility risk through the sale of premium in another expiration (calendar spread) or strike (debit spread).
For more detailed information on trading in low IVR conditions, particularly with calendar and debit spreads, we recommend the following links/shows:
tastytrade Learn: Low Implied Volatility Strategies
Market Measures: Low IV Strategies - Calendars
Options Jive: Debit Spreads in Low IV
If you have any questions on the topics covered in this post we hope you’ll reach out at firstname.lastname@example.org.
We look forward to hearing from you!
Sage Anderson has an extensive background trading equity derivatives and managing volatility-based portfolios. He has traded hundreds of thousands of contracts across the spectrum of industries in the single-stock universe.
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