Implied Volatility (IV) and Implied Volatility Rank (IVR) are both up in reaction to the unexpected results of the “Brexit” vote. Some may be fearful of such markets but a tastyliver should embrace the greater opportunities that high IV and high IVR provide. Why is it that high IVR provides greater opportunity?

Higher IVR provides greater opportunity because of three primary reasons. The first reason is mean reversion. Prices frequently snap back to their averages but not always. Our experience tells us that it always happens with IV. Volatility contraction will eventually happen and since we believe in selling option premium when IV is high we will benefit from the decline in option prices as volatility declines. Higher probability of profit (POP) is the second reason. Higher IVR lets traders sell farther out-of-the-money (OTM) strikes at the same Delta and without sacrificing premium as compared to when the IV Rank is lower. When IV reverts to the mean our shorts will be that much farther out on the curve.

The final reason that high IVR means a greater opportunity is that it allows us to take advantage of higher prices. Can we reduce our size without giving up premium? Our study was conducted in the SPY (S&P 500 ETF) from 2005 to present. We sold 1 Standard Deviation (SD) Strangles on the first trading day of each month and chose the expiration closest to 45 days to expiration (DTE). We compared the credits we received in four different VIX ranges. The four VIX ranges were the 0-25th percentile, 25th-50th percentile, 50th-75th percentile and 75th-100th percentile. The average credit received for the 1 SD Strangle for each level was listed and the corresponding reduction in size that could be used under the three higher IV levels to match the profit potential of the lowest percentile range. Between the highest IV range and the lowest a trader could almost cut his size in half for similar profit potential. Same reward for less risk.

For more information on IV and IVR see:

Market Measures from March 19, 2015: “IV and IVR | Finding Trade Opportunities”
Market Measures from June 1, 2016: “How Often Does High IV Occur?”

Watch this segment of Best Practices with Tom Sosnoff and Tony Battista for the key takeaways and a better understanding of why a tastyliver should embrace higher volatility as an opportunity to improve your probabilities and reduce your size.