Use Volatility for Option Strategy Selection

Volatility as Strategy SelectionIn this article we are going to discuss what effect Volatility has on the choice of Option Strategy Selection.

Important to option trading success is to know whether a rise or fall in volatility will help or hurt your position.

Some strategies should only be used when volatility is low, others only when volatility is high.

It is important to first understand what volatility is and how to measure whether it is presently high or low or somewhere in between, and second to identify the proper strategy to use given the current level of volatility.


How Implied Volatility Affects Options

The success of an options trade will be significantly improved by being on the right side of implied volatility changes. For example, if you own options when implied volatility increases, the price of these options climbs higher. A change in implied volatility for the worse can create losses, however, even when you are right about the stock’s direction!

Consider to sell options in order to collect option premium when volatility is high. If  volatility drops you buy the option back. The difference (profit) you may keep.

Each listed option has a unique sensitivity to implied volatility changes. For example, short-dated options will be less sensitive to implied volatility, while long-dated options will be more sensitive. This is based on the fact that long-dated options have more time value priced into them, while short-dated options have less.

Also consider that each strike price will respond differently to implied volatility changes. Options with strike prices that are near the money are most sensitive to implied volatility changes, while options that are further in the money or out of the money will be less sensitive to implied volatility changes. An option’s sensitivity to implied volatility changes can be determined by Vega – an option Greek. Keep in mind that as the stock’s price fluctuates and as the time until expiration passes, Vega values increase or decrease, depending on these changes. This means that an option can become more or less sensitive to implied volatility changes.

Read more:  investopedia


How do we know if IV is high?

We need to compare an underlying stock’s current implied volatility to where it has been over a certain period of time. The implied volatility number alone doesn’t do us much good unless we have something to compare it against. To do this we put context around the current level of implied volatility by using a measure we call IV Rank.

IV Rank shows us where the current level of implied volatility is in relation to the range that it’s been in over the previous 52 weeks. For example, if a stock has an IV of 20%, this might seem low at first glance, but if we know that the stock’s IV has been around 10% over the last year, then an IV of 20% is actually high. This would give the underlying an IV Rank of around 100, since it’s at the high end of the range it’s been in over the last year. When this occurs there might be more of an opportunity to sell premium since the option prices will likely be higher than when IV was less than 20%.

By putting context around implied volatility we can better understand if implied volatility is high or low and determine the appropriate strategy to use for a trade.

You can find Implied Volatility and IVR when you use TOS or Dough Platform.

Be sure to check out the first two videos in this series to learn more about why we choose to sell options premium in liquid underlyings.


Use Volatility for Option Strategy Selection

When you use volatility to determine strategy, not direction, you’re potentially putting its real influence on your side. Below we show option strategy selection when they have low or high IV.


Low IV strategies

  • Calendar
  • Diagonal
  • Debit Vertical Spreads

High IV strategies

  • Strangle
  • Straddle
  • Iron Condor
  • Iron Fly
  • Butterfly
  • Credit Vertical Spread
  • Jade Lizard


High & Low IV strategies