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What is Implied Volatility vs. Implied Volatility Rank?

By:Dr. Jim Schultz

Understanding what kind of movement and fluctuations the market anticipates can be valuable while analyzing trades

  • As premium sellers, understanding where volatility levels are in the market is a crucial element to being successful.
  • Implied volatility is the volatility metric fed directly into the option pricing models to determine option prices.
  • Implied volatility rank gives you a sense of where that specific stock’s volatility is, relative to where it has been over the previous year.

In the world of short premium market volatility one of the most important variables to track.

Understanding what kind of movement and fluctuations the market anticipates can be valuable during the trade-analysis phase. In the world of volatility, however, there are at least two different metrics you want to be aware of: implied volatility and implied volatility rank

Implied volatility

Implied volatility is a mathematical measurement of the future volatility that the market expects for a specific period. Different periods will almost certainly have various levels of volatility. A trade scheduled over a 30-day period will likely have a different volatility than a trade over a 45-day period. And that will have a different volatility than a trade over a 10-day period, and so on. Implied volatility is clearly important from a market movement standpoint. 

In addition, implied volatility also plays a direct role in determining option prices themselves. In an option pricing model, such as the Black-Scholes Model, a handful of market metrics are taken from the real-time markets, plugged into the model, and output what the option price should be based on those data. One variable inserted into the model—arguably the most important one—is implied volatility. As the implied volatility of a stock rises, its option prices will rise, and as the implied volatility of a stock falls, its option prices will fall. So, the first piece to putting together the market volatility puzzle is recognizing this role that implied volatility plays.

Implied volatility rank

An altogether different—but equally valuable to us at tastylive—measure of volatility is implied volatility rank. While implied volatility measures the future movement of the stock and gets input directly into the option pricing model, implied volatility rank looks at implied volatility itself to gauge whether it is relatively high or relatively low.

By comparing the current implied volatility to its range over the previous twelve months, implied volatility rank gives you a ranking of the implied volatility the same way that a standardized test score gives you a ranking of your performance

If the IVR on a stock is 70, then its current implied volatility is higher than 70% of all implied volatilities over the last year, so relatively high and a good short premium candidate. If the IVR on a stock is 25, then its current implied volatility is higher than 25% of all implied volatilities over the last year. That means volatility is relatively low, making the stock a less-than-optimal short premium candidate.

Jim Schultz, a quantitative expert and finance Ph.D., has been trading the markets for nearly two decades. He hosts From Theory to Practice, Monday-Friday on tastylive, where he explains theoretical trading concepts and provides a practical application of those concepts to a trading portfolio. @jschultzf3

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