One of the most important factors for premium sellers is Implied Volatility (IV). This means that an understanding of IV is something tastylivers need. We focused on four traits of IV. What are those four traits?
First, IV is Mean Reverting. A two year graph of IV with both the 45 day moving average (MA) and one year MA demonstrated this. Another graph, using as an example the 2008-2009 financial panic, offered more proof. A period of IV expansion will be followed by IV contraction.
Second, not only does IV expand and contract in general it also expands and contracts over the life of an option. This provides the opportunity to sell when IV is high and cover when IV is lower.
Third, IV is inversely correlated to equities. That means when equity prices rise IV generally decreases. When equities fall in price, IV generally rises. The harder equities fall the greater the inverse correlation to IV. Given that, we can hedge our short premium trades by keeping short Deltas.
Fourth, IV clusters. A graph helped to explain that although IV expands and contracts, it often exhibits a cluster of either high or low IV. This means that we don't have to jump into volatility the minute it increases. Volatility may move even higher and we probably will have a chance to sell a currently high level even if we wait a short time.
For more information on Implied Volatility see:
Options Jive: from February 17th, 2016: "The Benefits of Higher Implied Volatility"
Options Jive from April 13, 2016: "Three Key Concepts of Implied Volatility"
Watch this segment of Options Jive with Tom Sosnoff and Tony Battista for an understanding of 4 key traits of IV and how knowing this information can help us to take advantage of them in our trading.
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.