Know Your Option Premiums With IV Rank

The right way to follow option premiums for the longest time was following implied volatility and just kind of knowing the history of the stock you are following, which is still what I am talking about doing here but in a much more efficient way.  For those of you that already follow IV Percentile or IV Rank, then this post will probably be a waste of time for you to read unless you just love reading my amazing posts.  Surprisingly less people use this than I thought they would, which is the only reason I am making this post.  There isn't much to explain here so I will keep this one short (seriously this time).  IV Percentile is a tool that the founders of thinkorswim® came up with a long time ago, and they will tell you themselves that this is the biggest breakthrough in following options pricing they have come up with.. possibly even the biggest breakthrough in options trading period aside from ToS itself.  With that said, it should be a shocker that it is only found on ToS.  That isn't because of copyright laws or anything, it's because brokers don't understand what traders need in the front-end for the most part.

Here's what it is.. they take the 52 week implied volatility high and low and use it as the relative scale to base the current implied volatility on.  So basically if IV high is 50% and IV low is 0%, those are the two numbers we use for our 100% scale.  If IV was trading at 25% inside of that 52 week cycle, the IV Percentile would be at 50% because that is exactly half way between 50% and 0%.  It is a very simple way to see the context of the current options premiums.

If you look at the lower study here in this chart, you see the grey line (which is IV Percentile in line form) and those first two blue boxes.  The first one is IV percentile in number form and the second number is current implied volatility.  Normally (meaning without IV Percentile) you would look at that implied volatility sitting at 86% and say to yourself, 'man! those things are expensive right now!'  Not so fast..  Look at the IV Rank sitting at just above 40%.  That is less than half way up the scale I was explaining earlier, which isn't expensive relative to itself.  Sure, it may be expensive relative to other stocks but what good does that do you?  You want to know how expensive the options are in comparison to that stocks history.

If you look at the IV Rank line during those large sell offs spiking up to 100% multiple times, that is when options are relatively expensive.  Even above 50% as a general rule is relatively expensive and is a better time to be selling premium rather than buying it.  The opposite is true for low premium environments.  There are also more advanced strategies possible using this but I won't go into those right now.

If you haven't already asked yourself this, yes.. it is possible for it to get pinned to 100% and 0% while IV is making new 52 week highs or lows.  It has to do it at least once to set the range even if it is past IV becoming the new threshold, but that is still information you can use.  By using the study, you can see how steady or volatile the IV is in that stock.  In some stocks, the IV Rank stays flat for a very long time and you could adjust your strategies accordingly.  If IV Rank is continuously spiking up to 80%-100% and then falling off a cliff, then you can also use that to adjust your positions accordingly.

This is a really awesome tool for option traders and really simple as well.  The most simple way I can explain it is premium relative to itself.  Just like anything else in life.  If bread is selling for $10 a loaf, that is an extremely high premium for bread relative to what it normally is and there is likely a reason behind it.  Knowing the premium for pears really doesn't matter when you are looking at buying bread, so why would another stock's option's IV matter when you are looking at this stock option?

If you use ToS and you want the code for the study, go here and click on 'text attachment' next to the video and follow the directions.  You can also find it in 'options statistics' in the "All Products" under the Trade tab but that isn't the study, that is what you see in the first picture of this post.  If you aren't with them and you want to follow it, it is a very simple code if you can find a pro coder to do it for you or do it yourself.  Also on the study there is 1 day, 1 week, 1 month one standard deviation moves which is pretty useful for probabilities.

Again, this is a huge advantage to option traders and simply understanding this indicator/data point can greatly increase your probabilities in option trading if you are adjusting your strategies accordingly.  As always, I'm glad to clear anything up or answer any questions.. just use the comment section so everyone else can benefit from your question.  Hope you all learned something new.

Trade well,
-Michael