The ‘Street Smart’ Guide to Implied Volatility

[Image] The ‘Street Smart’ Guide to Implied Volatility Have you ever bought an option, guessed the right direction, but still lost money? Join the club. This is what makes options trading strange ... Sometimes, making the right directional guess can still result in a loss. How can this happen? Well, crafting an options trade is like cooking a meal. There are a variety of ingredients that go into making a five-star dish… And one of the most important "ingredients" in cracking options trading is implied volatility (IV)… This is especially true today as the Federal Open Market Committee (FOMC) meeting can have wide-ranging implications on the volatility of the options market. But if you don’t understand IV, it might ruin your position without you even realizing it (more on that later)... I’m here to make sure that doesn’t happen. Keep reading and I’ll show you everything you need to know about IV (and more)... How IV Works In short, IV gives us an idea of how much a stock's price might change in the future. It's shown as a % figure on options contracts. The % can be different values like 20%, 50%, or even 500%, based on a math formula. Most people use a method called the Black-Scholes model to find out the price of options. This model looks at several things like the market price of the option: the price of the stock it's based on, the agreed-upon price (strike price), how much time is left before the option ends, and the current interest rate… All of this helps to figure out the IV and the price of the options. To make it simple, if the IV is high, buying options will cost more. If the price of the stock doesn't change much, the IV will be low, and the options will be cheaper. Here’s an example: At the time of writing, Plug Power Inc. (NASDAQ: PLUG) and AMC Entertainment Holdings Inc. (NYSE: AMC) are trading close to each other, for $8.25 and $8.10, respectively… However, the 9/22/23 $8.50 Calls for PLUG are trading for $0.33, while the same strike and expiration date on AMC is training for $0.58. Why the big gap? Because AMC is considerably more volatile than PLUG. In other words, market makers know that there’s a higher probability of AMC making a massive move than PLUG. Therefore, the options cost more. It’s all about IV… Why IV Exists You may be wondering why this hurdle exists in the options market… The answer lies on the other side of the trade — with the market makers (the people who sell options). They need incentives to sell swingy contracts that could easily end up deep in the money. If someone’s going to sell a highly volatile call option, basic market efficiency calls for that person to be paid more premium for the sale than someone selling a call in a low-volatility stock. The options market functions much like a casino (but that doesn’t mean you should treat it like one). The market makers are the house. The house will give you better odds on a game with less probability of success. The house will also happily stiff you with bad odds on a game with a higher probability of success. The IV attached to options contracts exists to create this same sort of balance of odds in the options market. Where IV Comes From IV comes from market sentiment, specifically looking at the bid/ask spread… If many people are buying options at a certain price, the IV will go up, and the options will cost more. If many people are selling options, the IV will go down, and the options will be cheaper. You can make trades either way, which helps keep the market fair and working well. When more people want options, the IV goes up, making them worth more. But be careful: News events (like today’s FOMC meeting or an earnings report) can make the IV change a lot, especially for options that expire soon. If you aren’t aware of this, you could get blindsided when a high-IV contract you’re trading loses value because the underlying stock didn’t outpace the implied move. WARNING: Beware of IV Crush! Before big news comes out, a lot of people try to buy options. They hope to earn some money from the possible large changes in the stock's price that might happen because of the news. Lots of people want to join in, thinking they can make some money from the big changes that might happen in the stock's price. Because so many people are interested and are unsure about what will happen, the cost to buy options goes up, making them pricier. When the big news finally comes out, the uncertainty goes away because the market has the information it was waiting for. The stock's price changes based on this new information, but something else important happens at the same time - the IV usually goes down a lot. Why does this happen? It's because the big question everyone had has been answered. Now that the market has this information, people aren't guessing as much about what will happen to the stock's price in the future. This big and fast drop in IV is known as IV Crush, causing option prices to plummet… How can you avoid it? That’s simple … Don’t trade weekly options with extremely high IV (100%+). Closing Thoughts Because IV is a measurement of human behavior, it’s cyclical and can change based on a variety of factors. What that means is that IV is always fluctuating, which causes options to increase and decrease in value. That’s why when you buy or sell options, you need to be aware of where implied volatility could be going. So … next time you’re scanning the options market, make sure that IV is a data point you watch closely. It could make the difference between a and an account-ruining loss. Stay Street Smart, Jeff Zananiri P.S. You can watch the full replay of my recent conversation with Rob Booker and learn everything you need to know about my “Burn Notice” strategy [by clicking right here!](   66 West Flagler Street STE 900 Miami, Florida 33130 United States [Facebook]( [Twitter]( [Instagram]( [YouTube]( [Click Here to Unsubscribe]( **Our gurus teach skills others have used to make money. Any results displayed are extraordinary and are not typical and will vary from person to person. For more info read our [Earning Claims Disclosure]( About: Making money trading stocks takes time, dedication, and hard work. My goal is to teach you how I have succeeded in the market, but you may not achieve my results. Remember, there are risks involved with investing, including the potential loss of money. 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