Does High IV Mean Quick Profits?
Does High IV Mean Quick Profits?
By:Kai Zeng
For options premium sellers, entering trades when the implied volatility level is high can be a strategic move
- High volatility can work in a trader's favor.
- The influence of IV on trade management is equally significant.
- A higher IV rank produces greater trade credit and higher profits.
For options premium sellers, entering trades when implied volatility (IV) is high can be a strategic move.
The reason is higher IV typically translates to more expensive options premiums. For instance, a one-standard-deviation (1SD) strangle on the SPDR S&P 500 ETF Trust (SPY) can be 25% more lucrative when the IV rank (IVR) sits between 25 and 50, as opposed to lower IVR levels.
Furthermore, when the IVR exceeds 50, the premium jumps to 44% more expensive, offering an enticing proposition for traders aiming to maximize their credit from the options sold.
Trade management and IV
The influence of IV on trade management is equally significant. Traders often set a goal of managing or closing their positions once they've captured 50% of the maximum potential profit. It takes an average of 23 trading days to reach this 50% threshold for a 1SD Strangle, which is akin to managing trades at roughly 21 days to expiration (DTE) in a 45-day cycle.
Does a higher level of IV help in reducing the holding duration to reach the same profit target? An analysis of 45 DTE SPY 1SD Strangles over a 45-day cycle reveals some intriguing insights. Trades with a high IVR have a greater profit/loss (P/L) and exhibit higher volatility. However, managing winners at the 50%-mark results in a better daily P/L and lower volatility.
The daily analysis underscores that high IVR trades churn out a higher daily P/L throughout the expiration cycle. Yet, regardless of the IV Rank, strangles tend to reach profit targets, such as 50% of the maximum profit, in a similar number of days. This suggests the average duration remains consistent, comparable to managing trades at 21 DTE.
A higher IV rank produces higher profits
The results are simple, but the key takeaways for traders are insightful. A higher IV rank produces greater trade credit and higher profits, but also introduces higher volatility into the equation.
Despite this increased volatility, the period to reach 50% in profits remains relatively unchanged across different IV levels. This means traders who exit positions at certain percentage of the maximum profit point, mostly 50%, don’t need to worry too much about the remaining days to expiration. Consequently, over the long-term traders have the flexibility to exit positions at 21DTE, resulting in a similar trading duration.
Kai Zeng, director of the research team and head of Chinese content at tastylive, has 20 years of experience in markets and derivatives trading. He cohosts several live shows, including From Theory to Practice and Building Blocks. @kai_zeng1
For live daily programming, market news and commentary, visit tastylive or the YouTube channels tastylive (for options traders), and tastyliveTrending for stocks, futures, forex & macro.
Trade with a better broker, open a tastytrade account today. tastylive, Inc. and tastytrade, Inc. are separate but affiliated companies.
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.