Options Jive

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Which IV to Trust?

Options Jive

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

Here at tastytrade we like to look at the expected move to define the expected range of the underlying between now and expiration. There are three key components in the formula for calculating the expected move, namely the price of the underlying, the days to expiration (DTE) and Implied Volatility (IV). We have no control over the price of the underlying and our studies tell us we should choose the options closest to 45 DTE. That leaves IV. There are different IV types so which one of them do we choose?

An IV reference guide was displayed. The guide included strike IV, underlying IV, option chain IV and IV Rank (IVR) /IV Percentile (IVP) . The guide described each IV and when we would use each IV. The guide showed that strike IV was almost never used, underlying IV helped in the approximation of the underlying stock move, the option chain IV was the most precise around upcoming earnings and IVR/IVP was a great metric for trade selection in selling option premium.

Most of the time we use the underlying IV. An upcoming earnings announcement can change things. Usually front month volatility (before earnings) will be lower than back month volatility (after earnings). The expected range, based upon the 1 Standard Deviation range will be greater for the back month but an upcoming earnings announcement reverses this. A series of tables helped to demonstrate this and they served as a visual aid. The final table compared calculations of the 1 Standard Deviation range using weekly option chain IV versus using underlying IV in XYZ stock with an earnings announcement pending. The table showed the percentage range using the option chain IV of the weekly expiration was more than twice the percentage range when using the underlying IV. This showed the importance of choosing the right IV at the right time.

Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for the valuable takeaways and the importance of understanding the different IVs to use in trading and when to use them.

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