At tastytrade, implied volatility rank (IV rank) is an important tool that helps us sell premium effectively. When IV rank is high, option price have built in premium that should decay as implied volatility reverts to its mean. But how is this metric calculated, and how does it compare to another metric, IV percentile?
Jacob explains that IV rank looks at the minimum and maximum IV over a pre-determined time period, and then determines where we are at currently (between those bounds). IV percentile, on the other hand, looks at what percentage of IV observations over this time period fall below where we are currently. So, both measures are different, although they are likely correlated.
While IV rank is used by TOS and tastytrade, Jacob explains why IV percentile may be a stronger measure of where volatility stands compared to the past. IV rank is subject to bias if just one unnatural high or low IV value appears in the time period, while IV percentile treats each trading day the same and won’t be biased by outliers.
For the moment, IV rank is easier to compute and gives us a good idea of where current IV stands, but going forward IV percentile may become a more widely used measure.