Understanding Historical and Implied Volatility Ranking Through IV Percentiles

When trading options, you’re likely to see a lot of price changes. The magnitude and direction of these changes aren’t constant, though, so you need a way to track them. How do you track these changes? And how do you differentiate “normal” change versus the “not-so-normal” kind? 

One way to track changes is to compare the S&P 500® index (SPX) and the Cboe Volatility Index (VIX). Many traders believe these two indexes are inversely related. When the SPX rallies, the VIX tends to be low. And when the SPX drops, the VIX tends to move higher. So, an ultrahigh VIX might indicate an SPX bottom is near, and an ultralow VIX might indicate market exuberance or complacency. Of course, it’s good to remember these relationships are only trends, and markets can move in unpredictable ways. Past performance of trends does not guarantee the trend will continue in the future.

Ranking volatility for trading purposes is a little more nuanced, though. Some traders use the Implied Volatility (IV) Percentile and Historical Volatility (HV) Percentile readings on the Today’s Options Statistics subtab on the thinkorswim® platform when making trading decisions.

Implied volatility vs. historical volatility

Implied volatility (IV) indicates how much a stock could move in the future. Keep in mind that IV always changes because options prices are always changing, depending on how the market anticipates future price moves. For example, IV often rises ahead of expected stock price moves and falls after events like earnings announcements.

Historical volatility (HV) measures the fluctuation of past prices over a period of time. So, HV tells you how volatile a stock has been in the past. A stock with an HV of 10 has been less volatile than a stock with an HV of 35. It’s also possible for a stock to have an HV of 50 during one time period and 15 during another. 

You can use IV and HV percentiles when ranking volatility. To do this on the thinkorswim platform, pull up a stock, and under the Trade tab, open Today’s Options Statistics located below the Option Chain (see figure 1).  

IV is calculated from the prices of currently listed options and expressed in annualized terms. The IV percentile can range from near zero to near 100%. For example, the stock in the image above shows a current IV reading of 33.77%. This means the options market is essentially pricing in about a 34% variability around the current price. But again, that’s an annualized measurement. Other data on the page can help put it in perspective:

• 52-Week IV High/Low. Over the last year, the stock in figure 1 has seen IV as high as 72% and as low as 14.7%. 
• Current IV Percentile. The reading of 33% suggests that over the past 52 weeks, 67% of the time, IV was higher than 33.77% (the prevailing IV).

So, IV is relatively low in this stock right now. Is it warranted? One way to help you decide is by comparing the IV data to the HV data.

IV is a forward-looking measure implied by the options market, and HV is backward looking. HV is a moving average of actual price variability in the stock over the previous 52 weeks:

• 52-Week HV High/Low.Notice that, over the past year, the stock’s historical vol has been as high as 68% and as low as 15.2%. So, it’s been quite volatile at times and relatively static at other times.
• Current HV Percentile. At 29%, the current HV reading is a little lower than the current IV percentile.

Let’s review some implications of this comparison. If you expect IV and HV to follow each other up and down, an IV that’s lower than HV could potentially suggest IV is understating the stock’s potential price change. An IV that’s higher than HV could potentially suggest the opposite. In other words, comparing the two can be a useful way to understand how much expected volatility is being priced into options versus how much volatility actually tends to materialize. All else equal, higher IV relative to HV can suggest options are expensive, while lower IV can suggest options are inexpensive. Keep in mind, however, that IV is an estimate and past performance does not guarantee future results. 

Trading with the IV percentile

For option traders, volatility measures can be important when selecting a trading strategy. For example, a high IV percentile might indicate options premiums are relatively high, and there may be opportunities to use short options strategies like short vertical spreads, covered calls, or cash-secured puts. A low IV percentile might indicate options premiums are relatively low, and there may be opportunities to use long options strategies like calendar spreads or long vertical spreads. 

Regardless of which products you trade or how often you trade them, options statistics can help you track volatility and make more informed trading decisions.