Volatility levels are widely used by traders when making a decision to enter or exit a position. Understanding the differences between the various metrics of volatility can help gauge option pricing, and can be essential in your efforts to be more consistently profitable in your trading.

Implied Volatility Percentile (IVP) or Implied Volatility Rank (IVR) are two tools which can be used to track historical volatility. Using these tools will show you where the current IV number is in relationship to what volatility has been in the past.

When you learn to use the relationship of the current implied volatility and compare it to historical volatility by using either IV percentile (IVP) or IV rank (IVR), you will have an edge in your trading for many strategies. When you compare IV to IVP or IVR, it is important to use IVP consistently or IVR consistently. Comparing the current IV to both IVP and IVR can lead to confusion. It is important to either use IVP or IVR. Using IVP one time and IVR the next time is not recommended. Stay consistent.

When you look at the implied volatility (IV) of an option, it is reflecting the current IV. It is important to understand the relationship of the current volatility to the past historical volatility. This will help to determine what type of trading strategy to use when you enter a trade.

The can give your trading an edge.

To start, let's review the basics of Historical and Implied Volatility

**What is the definition of Volatility?**

**Historical Volatility**is a measure of past performance. Because it allows for a more long-term assessment of risk, historical volatility is widely used by traders and market analysts in the creation of investing strategies. Historical volatility is also referred to as realized or statistical volatility. For the purpose of this article, I am using current IV percentile as historical/statistical IV. IV Rank is another method to determine historical IV which you will also learn about in this article.**Implied Volatility (IV)**is the estimated volatility of a particular stock/index. IV is a calculation which reflects the current volatility. In general, implied volatility increases when the market is bearish, when investors believe that the underlying price will decline over time. Generally, implied volatility decreases in a bullish market, when investors believe the underlying price will rise over time. If there is a sharp move upward in price, there are instances when short term volatility may increase.

**How can Implied Volatility affect Options Traders?**

**Implied volatility is one of the key factors in the pricing of options.**Options give you the opportunity to purchase or sell an underlying at a specific price during a pre-determined period of time. The higher the implied volatility, the more premium the option will have. The less the implied volatility, the less the option's premium.**Knowing the relationship between implied volatility (IV) and current IV percentile**can allow you to determine if an option is more inexpensive or expensive…**Implied volatility has the biggest effect on the amount of extrinsic value in the price of an option.**When IV increases, the extrinsic value of both calls and puts increases. This makes the call and put option prices more expensive. When IV decreases, the extrinsic value of both calls and puts decreases. This makes the option prices less expensive. If you would like to read more about the intrinsic and extrinsic value of options, here is an article published on August 17, 2018: Intrinsic and Extrinsic Value of Options

**An option's value is determined by the following components:**

- Stock Price
- Strike Price
- Time to Expiration
- Volatility
- Interest Rates
- Dividends

Five of these components are easy to determine. They are basically fixed. The one which is unknown is volatility. As volatility goes up or down, it can reflect significant changes in the price of an option. Two of the most important components of an option's price are volatility and time to expiration. These two components can greatly affect your overall profit and loss. When you purchase an option, it is not enough to be right on market direction. You also have to be aware of time decay, volatility, and the relationship of current IV to its historical IV.

** What is IV Percentile?**

Implied Volatility Percentile (IVP) can provide traders with an additional metric to help gauge the pricing of options. IVP will tell you the percentage of days over the past year that implied volatility traded below the current level.

To explain IVP, let's start by looking at the current implied volatility using the S & P 500 Index as an example.

The one year chart of SPX is shown below, showing the current implied volatility of 21.67%.

Figure A. One Year SPX Chart indicating current Implied Volatility

Below is a screenshot taken from the Think or Swim option chain.

Figure B. Today's Options Statistics from Think or Swim

One way to find Current IV and IV percentile on the Think or Swim platform is to scroll down to the bottom of the option chain and look for Today's Options Statistics. It shows the Implied Volatility of 21.67%, as well as the Current IV percentile at 34%**. **

The current IV Percentile is calculated by taking the number of trading days the IV of SPX was below its current level and dividing it by 252 (the number of trading days in a year). The current IV Percentile in this example is 34%.

Using this example with IVP at 34%, the understanding can be that implied volatility of SPX traded below the current implied volatility of 21.67% for 34% of the past year, or about one-third of the year. This indicates that SPX IV was below 21.67% for about one third of the year. For two-thirds of the year, the implied volatility was above the current level of 21.67%.

This means that the current IV of SPX in relationship to its historical past is in the lower one third region. Therefore, option prices will be less expensive or “rich” than if the current implied volatility was at higher percentage.

**How do you know if the IV of an option is high or low in relationship to itself?**

**Here is an example:**

Stock ABC ‘s current price is currently trading at 50. The implied volatility of the stock is 20.0%, and the IV percentile is at 80%. Looking at an implied volatility of 20.0% you, would probably think the current IV was on the lower side.

Look at the Implied Volatilty Percentile. It is at 80%. What does this mean to you? It means over the past year 80% of the time ABC’s current IV was below 20.0%. This indicates ABC options are probably costly due to the current implied volatility of 20.0% relationship to the implied volatility percentile of 80.0%.

Remember, the current IV of 20.0% was lower 80% of the time over the last year. This shows the current IV to be high. This will make options more expensive or “rich”.

**Implied Volatility Rank is yet another volatility metric that many traders take into account when making their trading decisions…**

Implied Volatility Rank (IVR) can tell you whether the current implied volatility is high or low based on the IV over the past year. It is an average of the highest high and lowest low volatility for the past 52 weeks. Other time periods can be used such as 30 days with some trading platforms.

Let's use the same SPX example for one year to calculate IVR. The 52 week IV high was .468, and the 52 week IV low was .088. The formula used for a one-year IV rank is as follows:

Figure D. IV Rank Formula (photo courtesy of www.projectoption.com)

To calculate the one year IVR, look at the options statistics in Figure 2.

With SPX IV currently at 21.67%, the IV Rank would be calculated as follows:

Current IV (.2167) minus 1-Year IV Low (.088) = .1287

1-Year IV High (.468) minus 1-Year IV Low (.088) = .38

.1287 divided by .38 = IV Rank of .338 or 33.8%.

This IV Rank of 33.8% indicates that the current IV and the low IV is only 33.8% of the entire IV range over the past year. This means the current IV is closer to the low end of historical levels of implied volatility.

At the extreme levels, an IV rank of 0% means that the current IV is at the lowest point of the one-year range, and an IV rank of 100% means the current IV is at the highest point of the one-year range.

**How can you take advantage of the relationship between current Implied Volatility and IV Percentile or IV Rank?**

You can base the type of trade you place using Implied Volatility, IV Percentile and IV Rank. As you know, there are risks and rewards with every type of trade. A few strategies for consideration using high and low volatility levels are:

**High Volatility Could Indicate Opportunities to Sell**

You expect volatility to decrease, thus the option you sell could decrease in price, making it profitable.

**Credit spreads.**When you sell a credit spread, you will receive a higher credit when volatility is high.**Iron Condor.**When you sell an Iron Condor, you will also receive a higher credit when volatility is high.- When you buy a
**Butterfly**in a high volatility environment, your position will benefit as volatility drifts down, as long as the underlying price stays close to your short strike.

**Low Volatility Could Indicate Opportunities to Buy**

You expect volatility to rise, therefore, the option you buy could become worth more.

**Long put or put debit spread.**This trade can allow you to lower your cost and benefit from a spike in volatility.**Long Calendar spread.**This trade could benefit from the back month volatility increasing while the front month options decay.**Iron Condor.**The Iron Condor tends to perform better in higher volatility markets, but can still do well in lower volatility markets.

When you base your trade strategy on the relationships between Implied Volatility, and IV Percentile, and IV Rank, it does not guarantee that your trade will be profitable. However, it does give you a tool to use for your trade entries and exits so volatility can have a chance to work in your favor.

Do you have a trading method using volatility you would like to share? Please feel free to comment below.

]]>A calendar spread is a strategy often referred to as a time spread. A calendar is a method which could benefit from the time decay of an option and changes in implied volatility.

For the most part a calendar concentrates on the movement of time and volatility more than the movement of the underlying asset. For this reason a calendar spread can be used for either stagnant or large movements in the underlying.

Like any strategy the calendar has advantages as well as disadvantages. The risk can be quite limited for the buyer; the seller can have a larger risk. To contain some of the risk, a seller can act on the position at the expiration of the near term option. There are also strategies which can be used to lessen the seller’s risk.

One of the advantages of the calendar strategy is the position can be entered with less of an investment than purchasing the underlying asset.

**How is a Calendar Spread created?**

A Calendar spread is constructed by purchasing one option and the sale of another option in different expiration cycles in a one to one ratio. Both options will have the same strike price. The calendar can be created by using either two puts or two calls. The longer out in time option has more time value and will cost more than the closer in time option.

**How to construct a long Calendar…**

If you think the volatility is at a low level, you can buy a long calendar. To create a long calendar, you would purchase one option with an expiration further out in time and sell one option with expiration closer in time. As an example, you would buy a February 50 Call option and Sell a January 50 Call option. Another example, would be to buy February 50 Put option and sell a January 50 put option.

Figure A. Long Calendar Risk Graph from Think or Swim

As you can see in Figure A, the strike price of 50 is at the center of the risk graph. The highest profit potential is at the strike price.

**How you could profit from the long calendar spread…**

You can profit from a long calendar spread as time progresses and the price of the underlying stays favorable. The shorter term expiration will decay at a faster rate than the longer term position.

If the volatility increases the further out in time option will increase faster than the closer in time option. This will tend to increase the value of the calendar spread.

If you enter the calendar spread either in-the-money or out-of-the money and the price of the underlying moves towards the strike price, the position will gain in value.

**How you could lose from a long calendar spread… **

A decrease in implied volatility will decrease with the farther out in time option more quickly than it will decrease the value of the closer in time option. This will cause the position to lose value.

If the price of the underlying asset moves away from the calendar spread strike price, the calendar spread will decrease in value.

**How to construct a short Calendar Spread…**

If you have the assumption volatility is at high levels, you can create a short calendar. To create a short calendar, you would sell the farther out in time option and buy the nearer term option. For instance you would sell a February 50 Call option and buy a January 50 Call option.

Figure B. Short Calendar Risk Graph from Think or Swim

As shown in Figure B, the short calendar profits more as the underlying moves away from the center strike of 50.

*A word of caution concerning short calendar spreads. Shorting the longer dated option and buying the shorter dated option can be risky. The shorter dated option will expire before the longer dated option. This could lead to the seller of the longer dated option being naked that longer dated option. Therefore, the brokerage will most probably margin your account as though you are short the naked option. *

**How you could profit from a short calendar spread …**

If implied volatility decreases, the further out in time option which was sold will tend to lose money more quickly than the closer in time option which was bought. This is due to the higher Vega in the further out in time option. This will tend to create an increase in value to the seller of the calendar spread.

If the underlying asset moves up or down, away from the strike price of the calendar spread which was sold in either direction, it will tend to increase in value for the seller of the calendar spread, as long as the time decay of the option does not outdo the movement of the price of the underlying.

**How you could lose from a short calendar spread …**

As time passes it will usually negatively affect the seller of a calendar spread. This is due to the nearer term option, which is the long option for the seller, decaying at a more rapid pace than the farther out in time option, which the seller of the calendar spread is short.

If implied volatility increases it will also affect the seller of the calendar spread negatively. When the volatility increases the longer term option which was sold increases in value more quickly than nearer term option which the seller is long due to the longer term options higher vega.

**At-the-Money vs. Out-of-the-money and In-the-money options… **

Many times calendar spreads are entered at-the-money due to at-the-money options having the greatest amount of extrinsic value. The extrinsic value of an option will decay as the option gets closer and closer to expiration. This can be beneficial for a calendar spread because the strategy is looking for time decay.

There are other calendar strategies which can be constructed using out-of-the-money and in-the-money options. It is your choice.

The decay rate of the option with the same strike price, which has a longer expiration date will be slower to erode than the decay rate of the option which is closer to expiration. This applies to an in-the-money option, out-of-the money option or at-the-money option.

**Gamma’s Effect on the Calendar Spread…**

Gamma can be defined as the rate of change of the option’s delta as it relates to the movement in the price of the underlying. It can be thought of as the delta of the delta.

Gamma tends to be highest with at-the-money options in the nearer term expiration. Gamma will tend to decrease the further the price of the underlying moves away from the at-the-money strike and as the expiration date moves further out in time.

The nearer term option expiration will move more quickly due to its’ gamma being higher.

**How Does Volatility Influence a Calendar Spread?**

It is important to monitor the change in volatility when using the calendar spread strategy.

The volatility of an option is measured by vega. Vega is an approximate measurement of how much an options price will tend to change with a one point move in implied volatility.

Vega is shown in dollars for a one tick move or change in volatility. Let's say an option is valued at $2.00 and has 45 implied volatility with a vega of .05. Then the volatility moves up one tick to 46. The option would now have an approximate value of $2.10.

This is calculated by multiplying .05 times 2.00 which equals .10 or 10 cents. Adding the .10 to the original value of the option which was $2.00 equals $2.10.

**Key points about vega …**

- The price of an option will change as volatility increases or decreases
**Vega will tend to decrease with shorter dated expiration options**- Vega will tend to increase with longer dated expiration options
**Vega tends to be greatest with at-the-money options**- Vega applies to the strike price both calls and puts
**Vega will tend to increase when volatility increases**- Vega will tend to decrease as volatility decreases

**Wrapping up the Calendar Spread…. **

- Use two call options or two put options
**Use the identical strike price for both of the options**- Select different expiration periods for each option
**Create a one-to-one ratio**- Any two expiration periods can be used to create the calendar spread.

Usually, the calendar spread benefits when the price of the underlying is not moving too much and stays within a range.

If you have limited capital, the long calendar spread offers limited risk when entered as a debit. The risk is defined to the debit paid for the calendar.

You can use the calendar spread when volatility changes are expected.

As a seller of a calendar spread, you can take on potentially greater risk.

When the underlying price moves away from the calendar strike price, the buyer of a calendar will tend to lose money.

When the underlying price moves away from the calendar strike price, the seller of a calendar could increase profits as long as time decay does not surpass the movement of the underlying’s price.

If you have experience trading calendars, either long or short, and would like to share with the community, feel free to comment below.

Are you new to trading looking for mentoring, or an educational trade alert service? Or, are you a veteran seeking a trading group where you can interact with like-minded traders who share their experiences? Look no more. Join Aeromir today!

]]>The value of the SKEW Index rises with the tail risk of the S & P 500 Index. When there is no tail risk, SKEW is equal to 100. When SKEW is close to 100, probabilities of a sharp market move remains small. As the probability of a major market move increases, the SKEW index rises.

The mathematical definition of “standard deviation” is a measure of the dispersion of a set of data from its mean. The more the data is spread apart, the higher the deviation.

These standard deviations are important to options traders because they give definitive metrics which can be used to gauge the probability of a successful trade. Of course, there is no indication of the direction of a potential move; you as a trader can use your own technical expertise and chart analysis in conjunction with the standard deviation metrics. It is also worth mentioning that no trade can have a 100% probability of success. Even trades with boundaries of profitability of three standard deviations have the small but real probability of moving outside the predicted range of movement.

Represented by a bell curve, the graph below illustrates standard deviation and a normal distribution curve:

Figure A. Normal Distribution Graph (Image courtesy of Wikipedia.org)

If the data points in the distribution graph are all near the mean (center of the graph), then the standard deviation is close to zero. The farther away the data points are from the mean, the higher the standard deviation. The bell curve in Figure A is a normal distribution, and demonstrates that among a certain number of samples, there is normal outcome. In options trading, these normal outcomes can be used as a tool.

Breaking this outcome into percentages:

• +1/-1 standard deviation covers 68.2% of occurrences

• +2/-2 standard deviation covers 95.4% of occurrences

• +3/-3 standard deviation covers 99.6% of occurrences

Now, compare the normal distribution graph to ones that are skewed (to the left or the right). The chart below illustrates a normal distribution graph, as well as skewed graphs.

Figure B. Distribution Curves (image courtesy of assetinsights.net)

In Figure B, the Positive Skewness (curve on left) has a longer tail to the right, which indicates more tendency of upside risk. The Negative Skewness (curve on right) has a longer tail to the left, which indicates more tendency of downside risk.

**How is the SKEW Index calculated?
**

SKEW is calculated from the prices of S & P 500 options using a similar type of algorithm as that which is used to calculate the VIX, which is the CBOE Volatility Index. The mathematical calculation of SKEW can be found here: SKEW Index calculation

The SKEW Index typically ranges from 100 to 150, with a historical average of approximately 115. The higher the SKEW index rating, the higher the perceived tail risk and chance of a significant move.

Below is a 3 year, weekly chart of the SKEW Index from Think or Swim

Figure C. 3 year weekly SKEW Chart

The 20 period moving average is showing a value of 138.45 in Figure C above. The current SKEW value is 144.49. Since the SKEW's historical average value is approximately 115, the current SKEW of 144.49 is higher than normal. A trader who is fearful of increasing volatility may want to be cautious.

**How can traders interpret the SKEW Index?
**

While the SKEW index itself cannot be traded, investors may use it to help determining market risk. In general, the SKEW index rises to higher levels as investors become more fearful of a major, unexpected selloff of a large magnitude – a “black swan” event.

As the slope of implied volatility rises, the SKEW Index tends to rise. This may indicate an increase in the probabilities that a major market-moving event is forthcoming. It doesn’t, however, necessarily mean it will happen.

By monitoring the SKEW as it increases over 100, traders may choose to hedge their portfolios, add to current hedges, etc. As with any technical indicator, the SKEW index should be used in conjunction with other technical analysis such as support and resistance, volume, etc.

**Is the SKEW Index related to the VIX?**

The SKEW and VIX indexes are different from each other; yet complementary in terms of measuring the risk of the returns of the S & P 500 over a 30-day period. The VIX is a fairly close representation of the standard deviation of those returns, but this sometimes is not enough to measure the true risk because over time the distribution of the S & P 500 returns exceeds one standard deviation.

The SKEW index describes the tail risk of the distribution; it is a measure of the S & P 500 returns that are greater than two or three standard deviations below (or above) the mean.

Below is a one year daily chart, showing both VIX and SKEW.

Figure D. VIX/SKEW 1 year Daily Chart

Figure D above shows the correlation of SKEW and the VIX. From late December through the middle of January the VIX was hovering around 10 (right axis). At the same time, the SKEW index was in the 120’s to 130’s (black line/left axis). During this period, SPX was continuing to move up in price, as you can see in Figure E below. A trader could interpret this to be an indication of a possible large move in price because SKEW was in the 120 to 130 range. The VIX reached a high of 50.3 on February 6th 2018; at the same time SKEW was around 133.

As with any indicator, signals can be tricky. As an example, please take note of the low price of SKEW (117.99) on January 26, 2018. At the same time the VIX was trading around 10. The SKEW had moved down to 117.99 from its’ previous higher levels, indicating less of a risk of a major market move. This occurred just before the price of SPX started to decline dramatically. A trader may interpret this as a mixed signal.

Figure E. SPX 1 Year Daily Chart

Here’s a good video to watch by Alessio Rastani, which shows other scenarios of the SPX/VIX/SKEW correlation, to forecast a potential large move in the market.

Go to…How to Predict a Fall in the Stock Market

**In summary …
**

A trader cannot use the SKEW Index itself as an instrument to place a trade. What it can do for traders is to measure current market risk. The SKEW index for the most part ranges from 100 to 150. The SKEW Index usually rises in market uncertainty.

The SKEW Index is one more tool for traders to have available to them to make a more informed decision on their positions and portfolio.

Any one indicator you as a trader choose to incorporate into your technical analysis is not going to make you money unless you use it consistently, and this holds true for the SKEW index.

Following the SKEW index along with its relationship to the VIX, as well as price action, may give traders an insight on overall market risk.

If you have found that monitoring the SKEW index has been helpful in your trading and would like to share, feel free to comment below.

Are you looking for a mentoring program, educational alert service, or a group of like-minded traders to share both positive and negative trade experiences? Look no more, join today!

You will find a wide variety of educational services in addition to the trading groups that meet on a regular basis to exchange their trades and ideas.

]]>Bollinger Bands are a technical indicator created by renowned technical trader John Bollinger in the early 1980's. There are numerous publications, as well as John's website www.bollingerbands.com, that go into great detail on this popular tool used by many traders. This article will touch on the basic parameters of Bollinger Bands and how they may be used in options trading.

Bollinger Bands are considered to be a volatility indicator, similar to the Keltner channel indicator. Their purpose is to provide traders a relative definition of highs and lows. This means that prices are high at the upper band, and low at the lower band. Bollinger Bands can help recognize price patterns, and can be useful to traders of all levels in their trade entry, management and exit strategies.

Below is a screenshot of a chart of the SPX with Bollinger Bands set at their default settings:

SPX 6 Month Chart from Think or Swim with Bollinger Bands

The Bollinger Bands study as shown on Thinkorswim consists of two lines plotted, two standard deviations above and below a moving average. The standard deviations can be changed based on a trader's choice, as can the other settings will are explained below. The standard deviation lines change as price and volatility goes up or down.

The upper band can indicate an overbought level, while the lower band can indicate an oversold level. However, as we have all seen at times, if prices approaches either band, or bounces off, it is not a guarantee of a breakout or reversal.

The default settings in the above Think or Swim chart are shown below:

**Close**This represents the price which is used to calculate the moving average and the standard deviation. Depending on which charting software is being used, traders can choose other parameters such as open, volume, etc.**0**This is the “displace” setting; the number of bars to shift the study forward or backward. TOS' default setting of zero is preferred by many traders.**20**This is the “length” setting; the number of bars used to calculate the moving average and standard deviation. In this case 20 is the 20-day simple moving average.**-2.0, 2.0**These two settings are the number of standard deviations up and down to plot the lower bars**Simple**This is the moving average; this can also be changed to Exponential, etc., based on a trader's preference. On the chart, the moving average is the middle line, and the upper/lower lines represent the standard deviations up and down as selected.

The way traders interpret and use Bollinger Bands varies, depending on the individual and trading style. Some choose to buy when price touches the lower Bollinger Band, and close the position when the price rebounds to touch the moving average (center line). Others may choose to go long when price breaks out above the upper Bollinger Band, or go short if the price falls below the lower band. It is also worth noting that the use of Bollinger Bands is not limited to stock traders. Because the Bollinger Bands indicator is a volatility study, some options traders sell options when the bands are spread apart, or buy options when the bands are close together. In both of these cases, the trader is expecting volatility to retrace to the average historical volatility level for that particular underlying.

When the Bollinger Bands are close together, it usually indicates a period of low volatility. On the other side of the coin, as the bands expand and move farther apart, an increase in volatility is indicated. Lastly, when the bands only have a slight slope and track fairly even for a period of time, it indicates that the price of the underlying may continue to channel in between the bands.

Many traders also like to use Bollinger Bands in conjunction with other indicators to confirm price action, such as a trendline. If the trendline confirms the movement suggested by the Bollinger Bands, the trader may have more confidence that the bands are predicting a correction in the price action in relation to market volatility.

I hope this “Bollinger Bands in a Nutshell” has given some of you an insight on this popular technical indicator. Like all the technical indicators, they are not “guaranteeing” price action, but can be used as a guide for traders in their entry, management, and trade exits. Subsequent articles will cover more technical indicators widely used by traders of all levels.

“Capital Discussions is a great resource for education and learning more about options trading. It is a great community with traders who are always willing to share and help each other.”

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]]>I remember during market crashes in the past, Interactive Brokers (IB) increased the margin for many products.There was a lot of complaining about it on certain forums but I personally was happy to see the increased margins. As an IB customer myself, I like knowing rogue traders with too much risk are not going to destroy the brokerage firm with my funds in it. It's happened before to other brokers and I trust IB to keep risk under control.

It's no surprise to anyone that the British referendum to leave the EU (BREXIT) is on Thursday, June 23, 2016. The markets are extremely uneasy about this important vote and volatility has exploded in the past week. To keep risk to IB under control, IB sent a notice today that they are increasing margin for certain products conntected to the Brexit vote. Here's the mail they sent out:

On 23 June 2016, the UK will vote on a referendum (i.e., BrExit) to decide whether to remain a part of the European Union. This vote is expected to create substantial market volatility in the days leading up to the vote and perhaps even greater volatility should the final vote be for the UK to separate from the EU. The market consensus suggests that separation would lead to a weaker GBP, lower equity prices in the short term, and a possible secondary adverse effect on the EUR due to the precedent setting event of a country leaving the EU.

In anticipation of this volatility, Interactive Brokers will be increasing margin across a range of products, as follows:

- GBP currency/assets: maintenance margin 7.5% (now 2.5%), initial margin 12% (now 9%)
- EUR currency/assets: maintenance margin 5% (now 3.0%), initial margin 5% (now 4%)
- GBP/EUR currency futures: same margins as for spot FX above
- GBP/EUR currency options: scanning range for maintenance margin will increase to 7%.
- FTSE index derivatives: scanning range for maintenance margin will increase from 5.6% to 8%
- GBP denominated stocks: portfolio margin maintenance of 20% (already in place)
- CFDs on GBP denominated stocks: same as the underlying stock
- UK linked stocks (for example, ADRs on UK stocks: portfolio margin maintenance will increase to 20%

These changes will be going in over the next 4 business days with the increases to initial margins occurring first. We urge all clients with substantial positions in products that are considered exposed to the BrExit vote and, in particular those with net short option positions, to prepare for substantially higher upcoming margin requirements and adjust their risk and/or capital positions accordingly.

Interactive Brokers Client Services

When you determine the difference between a stock's implied volatility and its current IV percentile, you could have an edge in your trading. This could help you become a more consistently profitable trader.

“If you want to have a better performance than the crowd,

you must do things differently from the crowd.” Sir John Templeton

**Historical Volatility**is a measure of past performance. Because it allows for a more long-term assessment of risk, historical volatility is widely used by traders and market analysts in the creation of investing strategies. Historical volatility is also referred to as realized or statistical volatility. For the purpose of this article, I am using current IV percentile as historical/statistical IV.**Implied Volatility (IV)**is the estimated volatility of a particular stock/index. In general, implied volatility increases when the market is bearish, when investors believe that the underlying price will decline over time. Generally, implied volatility decreases in a bullish market, when investors believe the underlying price will rise over time. If there is a sharp move upward in price, there are instances when short term volatility may increase.

- Implied volatility is one of the key factors in the pricing of options. Options give you the opportunity to purchase or sell an underlying at a specific price during a pre-determined period of time. The higher the implied volatility, the more premium the option will have. The less the implied volatility, the less the option's premium.

An option's value is determined by the following components:

- Stock Price
- Strike Price
- Time to Expiration
- Volatility
- Interest Rates
- Dividends

Five of these components are easy to determine. They are basically fixed. The one which is unknown is volatility. As volatility goes up or down, it can reflect significant changes in the price of an option. Two of the most important components of an option's price are volatility and time to expiration. These two components can greatly affect your overall profit and loss. When you purchase an option, it is not enough to be right on market direction. You also have to be aware of time decay and volatility movement.

**Implied volatility has the biggest effect on the amount of extrinsic value in the price of an option.**When IV increases, the extrinsic value of both calls and puts increases. This makes the call and put option prices more expensive. When IV decreases, the extrinsic value of both calls and puts decreases. This makes the option prices less expensive.

**Intrinsic value**is the amount by which an option is in the money. In the case of a call, the intrinsic value is equal to the current stock price minus the strike price. For puts, the intrinsic value is equal to the strike price minus the current stock price. Only in-the-money options have intrinsic value.

**As an example, let's say the price of the RUT underlying is 1184.**

Price of RUT | 1184 |

Less: RUT call strike | 1170 |

Intrinsic value = | 14 |

**Extrinsic value**is defined as the price of an option less its intrinsic value. In the case of out-of-the-money options, the entire price of the option consists only of extrinsic value.

**As an example, let's say the price of the 1170 RUT call option is 25.70.**

RUT 1170 call price | 25.70 |

Less: Intrinsic Value | 14.00 |

Extrinsic value = | 11.70 |

Below is a RUT option chain, indicating the implied volatility, extrinsic, and intrinsic value of at-the-money and out-of-the money calls.

Knowing the relationship between implied volatility (IV) and current IV percentile will allow you to determine if an option is more inexpensive or expensive.

Let's start by looking at implied volatility using the Russell 2000 as an example.

The one year chart of RUT is shown below, showing the current implied volatility of 18.33%.

Below is a screenshot taken from the Think or Swim option chain. You can find it by scrolling down to the bottom of the option chain and look for Today's Options Statistics. It shows the Implied Volatility of 18.33%, as well as the Current IV percentile at 15%.

ThinkOrSwim calculates the Current IV Percentile by using the 52 Week IV high of 0.404 and the 52 week IV Low of 0.143. This is a historical / statistical calculation of IV over the past 52 weeks. The current IV Percentile in this example is 15%.

Implied Volatility is at .1833. The Current IV percentile is at 15%. So this means that 15% of the time over the past 52 weeks RUT Implied Volatility was below .1833. This indicates option volatility is relatively low. Option prices are relatively inexpensive. Therefore, it may be a good idea to use strategies with buy opportunities. You expect the price of the option to increase in this low volatility environment.

You can base the type of trade you place using Implied Volatility and the current IV Percentile There are risks and rewards with every type of trade. A few strategies that you can take using high and low volatility levels are as follows:

You expect volatility to decrease, thus the option you sell could decrease in price, making it profitable.

**Credit spreads.**When you sell a credit spread, you will receive a higher credit when volatility is high.**Iron Condor.**When you sell an Iron Condor, you will also receive a higher credit when volatility is high.**Butterfly.**When you buy a Butterfly in a high volatility environment, your position will benefit as volatility drifts down, as long as the underlying price stays close to your short strike.

You expect volatility to rise, therefore, the option you buy could become worth more.

**Long put or put debit spread.**This trade can allow you to lower your cost and benefit from a spike in volatility.**Long Calendar spread.**This trade could benefit from the back month volatility increasing while the front month options decay.**Iron Condor.**The Iron Condor tends to perform better in higher volatility markets, but can still do well in lower volatility markets.

There are many methods using volatility which could increase your odds of success trading. Today's article talks about just one of them. There are many volatility methods shared at https://capitaldiscussions.com/.

When you base your trade strategy on the relationship between Implied Volatility and current IV Percentile, it does not guarantee that your trade will be profitable. However, it does give you a tool to use for your trade entries so volatility can have a chance to work in your favor.

Do you have a trading method using volatility you would like to share? Please feel free to comment below.

]]>One measure of risk that is common for option traders is to use standard deviations of movement. I built a popular Standard deviation calculator to calculate the range of movement for a given set of numbers. It was accessed nearly 500 times in the past week!

An option trader can also use Delta to estimate the probability that an option will expire in the money. If you sell an iron condor, you would add up the absolute values of the deltas to give you the rough approximation of the probability of the entire trade expiring in the money.

Many of the Capital Discussions members trade the RUT as the underlying. Let's put a hypothetical trade on:

Symbol | Expiry | Action | Quantity | Strike | Type | Price | Delta |
---|---|---|---|---|---|---|---|

RUT | JUL5 | BUY | +10 | 1310 | CALLS | 2.28 | +9.46 |

RUT | JUL5 | SELL | -10 | 1290 | CALLS | 6.20 | +21.4 |

RUT | JUL5 | SELL | -10 | 1200 | PUTS | 11.15 | -20.5 |

RUT | JUL5 | BUY | +10 | 1180 | PUTS | 7.85 | -14.5 |

Here is a summary of the position:

Delta | Gamma | Theta | Vega | DTE | SV | ATM Call IV |
---|---|---|---|---|---|---|

-59.16 | -3.72 | 193.3 | -576.3 | 25 | 11.7% | 18.7% |

This is what it looks like in OptionVue software:

If you look at the full size image, you'll see on the left that OptionVue is estimating an 83% probability of profit at expiration. Pretty good right?

Statistical Volatility (SV) is backwards looking and shows you what the underlying actually did. Implied Volatility (IV) is normally what traders use to look forward to estimate their probabilities. A common IV is the Call at-the-money IV for the expiration you are trading in. In this case, that's a volatility of 18.7%, which is 7.0% higher than SV in our example. The market is anticipating higher volatility.

Notice the two standard deviation range expanded quite a bit. The price went from 1174.22 to 1131.95, or a 42.27 point further drop! Our probability of profit went from 83% to 61%. Ouch. Not quite as safe as we thought it was.

Volatility will increase. Let's look at the volatility chart to see how much it might go up:

It is reasonable to assume volatility could rise an addition 3% if the market sells off. Let's bump the volatility up to 21.7% and see how things look:

Things got even worse! Our probability of profit isn't 83% but is now at 54%. Our two standard deviation move lower boundary is at 1114.32, or 59.90 points lower that we initially thought it was.

When you are evaluating a trade during lower volatility, you can often find very comforting percentages, but if volatility rises, the numbers get worse very quickly. Be prepared for fast moving markets and plan on volatility rising. Don't assume the probability of profit will remain the same or improve as time passes. If you get a quick market move and volatility spikes, your beautiful risk chart can transform into an ugly chart very quickly.

Don't get lulled into a false sense of security. Plan on volatility rising and the standard deviation ranges expanding as volatility rises.

]]>Enjoy the replay!

]]>Steve Lentz, from OptionVue and Discover Options, presented “Volatility Edge Analysis of the Russell 2000.” Steve's data was very intriguing and showed how ofter option sellers have an edge on in the RUT. Steve is trying to use technical analysis to improve the edge and his results are promising.

Enjoy the replay!

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Jim sent me an interesting link to six figure investing's article on "Thirteen Things Your Should Know About Trading VIX Options." Bullet point number four says

"The option greeks for VIX options (e.g. Implied Volatility, Delta, Gamma) shown by most brokers are wrong (LIVEVOL and Fidelity are notable exceptions). Most options chains that brokers provide assume the VIX index is the underlying security for the options. In reality, the appropriate volatility future contract is the underlying. (e.g., for May options the May VIX futures are the underlying)."

]]>I posted in the forums about seting up OptionVue correctly to get the correct greeks for VIX options.

Jim sent me an interesting link to six figure investing's article on “Thirteen Things Your Should Know About Trading VIX Options.” Bullet point number four says

“The option greeks for VIX options (e.g. Implied Volatility, Delta, Gamma) shown by most brokers are wrong (LIVEVOL and Fidelity are notable exceptions). Most options chains that brokers provide assume the VIX index is the underlying security for the options. In reality, the appropriate volatility future contract is the underlying. (e.g., for May options the May VIX futures are the underlying).”

I've used OptionVue software since 2006 which made me wonder if OptionVue was using the underlying future to calculate the greeks so I asked Len Yates, the co-owner of OptionVue. Len said to load the VX futures contract as the underlying in the matrix and that will correctly calculate the VIX greeks.

If you aren't using OptionVue or LiveVol, be very careful of the greek values on VIX options.

I'm in the process of getting LiveVol X and will be able to update this article with data from ThinkOrSwim, OptionVue and LiveVol and compare the values for the same instruments.

Stay tuned for that (or sign up for our RSS feed or email updates to have it sent to you automatically)

Are you trading the VIX or any volatility products?

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