Many option traders are aware of Implied Volatility (IV) but at tastytrade we also make use of IV Rank (IVR) which we help use to determine if an option is cheap or expensive by comparing its current value against the year long range. This generally works well; however, an outlier move can distort IV rankings, although IV percentile is not really impacted. How exactly does IVR work, how do outlier moves affect IVR and why should IVR levels improve soon? The head of our research team, Michael Rechenthin, Ph.D., aka Dr. Data, joins the guys to explain things.
IV Rank tells us where the current IV lies with respect to its 1-year high and low. For Example: An IV Rank of 9% is 9% from its yearly low and 91% from its yearly high. A graph was used to help visualize the concept. Another graph showed that we have just come off the yearly lows and are still near them. IVR can also comprise shorter or longer time periods but we prefer one year.
Because it is calculated using a one year time frame each day an old day is dropped from the calculations and a new day is added. A graph was shown to demonstrate the one year window. One year ago the S&P 500 experienced a huge move down over just a few days. The high on Thursday, August 20, 2015 was 2076.61 and the low on Tuesday, August 25, 2015 was 1867.08. As one would expect, IV shot higher. This outlier move changed things. Dr. Data explained how an outlier move throws off the yearly curve. He informed us that we have not reached a 50 IVR all year long in the major indexes. The markets normalized and IV declined. When we reach September 2, 2016 the outlier move will be out of the year long data. Mike explained how after September 2nd IV will only have to reach 20 to be at a 50% IV Rank as opposed to 27 now.
For more on IV Rank and IV Percentile make sure you watch the segment of Skinny on Options Data Science from November 12, 2015, "IV Rank and IV Percentile (w/ thinkscript)"
Watch this segment of The Skinny On Options Data Science with Tom Sosnoff, Tony Battista and Dr. Data, aka Mike Rechenthin Ph.D., for the valuable takeaways and a better understanding of how yearly IVR works, how outlier moves affect IV Rank and how things will be change after September 2, 2016.
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