Implied Volatility (IV) overstates the expected move predicted by the theoretical model. Our studies at tastylive have proven this to us and the edge this provides is a big reason why we are option premium sellers. The Market Measures from May 13, 2016: “U.S. Indices: Actual Moves vs Expected Moves” showed that the expected moves are overstated in all environments. A graph displayed the percentage of days the S&P 500, Nasdaq and Russell 2000 are within the four Implied Volatility Rank (IVR) percentage ranges. The graph showed that the indices stay within 0-25% IVR most of the time with 75-100% the least. So although we know the expected move is overstated overall, is it also overstated in the lowest IVR percentage range where it most often is?
Our study was conducted in the SPX, NDX and RUT from 2005 to the present. We calculated the IVR every day (6500 occurrences) and compared actual moves to the 1 Standard Deviation expected moves for 45 days. We tested for when IVR was below 25% and when it was 25-50%.
A table of the results showed that volatility was overstated from actual when IVR was trading below 25%. It further showed that the expected move was overstated the most when it was in the 25-50% range. Our previous studies though have indicated that the highest IVR range, above 75% is the most profitable but occur the least amount of the time.
For more on Implied Volatility and Volatility Overstatement see:
Market Measures from March 3, 2015: "Historical Versus Implied Volatilities"
The Skinny On Options Math from April 16, 2015: "Implied Volatility & Option Pricing"
Market Measures from December 3, 2015: "Low IV Overstatement"
Watch this segment of Market Measures with with Tom Sosnoff and Tony Battista for the important takeaways and the results of our study which show that implied volatility is overstated in low IVR, and how there is still an opportunity in selling premium in relatively low IV.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.