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IV Adjusted Notionals: A Shifting Metric

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Here at tastytrade, we often talk about pairs trading and adjusting pairs by their IV notional equivalent. How does this metric change with respect to movement in the underlying?

Recall the way we adjust the notional value is by multiplying the price of each asset by the IV. To find the ratio, we divide the larger IV adjusted notional by the smaller one. Adjusting products by implied volatility can be beneficial if one side of your pairs trade has a much higher volatility.

Though candidates for pairs trades are often highly correlated, they do have risks that are unique to each product. These idiosyncratic risks might not be reflected in the price, but in the volatility. As traders, we need to watch this metric and its changes, especially when initiating and managing positions. Be sure to tune in to hear Tom and Tony discuss this topic in more detail.

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