Whether it is options trading or an individual stock, volatility plays a major role in defining your profitability. It not only tells you how much the price of the underlying stock in the option contract has moved but also gives an idea of how it will fluctuate in the future. However, to determine whether the current volatility is high or low in contrast to the underlying asset’s own history, you need to learn about Implied Volatility Rank (IVR). But before that, let’s discuss implied volatility.
What is Implied Volatility?
Implied volatility in options trading shows how much the market expects a stock’s price to move in the future. It doesn’t predict direction, only the expected size of the movement.
A high IV means the market expects big price swings, while a low IV suggests smaller changes. IV is influenced by market demand for options and upcoming events like earnings or news.
What is Implied Volatility Rank (IVR)?
IVR shows where the current IV stands compared to its past values over the past year. It helps you decide if options are relatively expensive or cheap. To learn more, you can enroll in option trading courses from Upsurge.club.
The rank is expressed as a percentage between 0 and 100. Here is how to read it:
- IVR of 0: Current IV is at its lowest point in the past year.
- IVR of 100: Current IV is at its highest point in the past year.
- IVR of 50: Current IV is exactly in the middle of its 1-year range.
How Does Implied Volatility Rank Work?
Here is an example to help you learn IVR better.
Suppose you are tracking the stock of ABC Ltd. Over the past 12 months, the implied volatility has ranged between 20% (lowest) and 80% (highest). Today, the current IV is 70%.
Now, where does 70% stand between 20% and 80%?
It is near the top of the range. This means IV is high compared to its historical levels, and options are more expensive. The IVR, in this case, would be high, around 83%. This signals that 70% IV is higher than 83% of all values recorded in the past year.
How to Calculate Implied Volatility Rank?
Suppose you are looking at a stock that typically has a historical volatility ranging from 20% to 40%. If the current IV of the options on this stock is 30%, you calculate IVR as follows:
IVR = 100 × (Current IV – Lowest IV in the Recent Period) ÷ (Highest IV in the Recent Period – Lowest IV in the Recent Period)
Assuming the lowest IV in the recent period was 20% and the highest was 40%:
= [(30% – 20%) × 100] ÷ (40% – 20%)
= (10% × 100) ÷ 20%
= 50%
This means the current IV (30%) is halfway between the lowest (20%) and highest (40%) volatility observed recently. An IVR of 50% indicates that the current IV is moderate compared to its recent range.
Conclusion
IVR does not just show how volatile a stock might be; it tells you where the current implied volatility stands in comparison to its past levels. A higher IVR suggests pricier options, possibly ideal for selling strategies, while a lower IVR indicates cheaper premiums, better suited for buying. Enroll in option trading for beginners from Upsurge.club to learn more.
