Options volatility is a popular topic among traders. Looking at volatility from a trading capital, past activity, or probability lens may give you better insight.
Option traders love to look at and discuss volatility (vol). Many option traders monitor the Cboe Volatility Index (VIX) and try to choose an appropriate options trading strategy for a given level of implied volatility (IV).
This makes sense because mechanically, vol can impact the price of an option. Implied volatility, for example, is derived from current options prices via a pricing model. So vol can definitely inform you about options prices. But they’re not the same thing. Looking at price and vol as equal can be misleading. Viewing vol through a slightly different lens could help clear up some misunderstandings and help you see how vol can be a trader’s friend when buying stocks or selling options. Volatility is a forecast that indicates the state of the market and stock at the present moment. Keep in mind, those expectations can change, sometimes very quickly.
Monster stocks with prices above $500 per share—the kind that can move $20 or more in the course of a typical trading day—attract a lot of attention. After all, a $20 move can mean a lot of money. If you own 100 shares of such a stock, that’s a $2,000 move. But is all the opportunity, or the risks, in high-priced stocks?
Nope. Those $20 moves may be impressive, but don’t confuse dollar changes with percentage changes, which is what volatility is all about. Let’s do a little math:
So a $2 move in a $50 stock is a larger percentage change (4%) than a $20 move in a $600 stock (3.3%). If a trader invested, say, $5,000 in each trade in this example, they would’ve seen more profit (or loss) with the $50 stock because they’d control more shares.
To take this one step further, because stock price is an important variable in any options pricing model, the options prices on a higher-priced stock will generally be greater than the options prices on a lower-priced stock—volatility and all other things being equal. You’ll likely see out-of-the-money (OTM) options on a $600 stock with high premiums compared to the options on a $50 stock. But trading a high-priced option on a high-priced monster stock doesn’t necessarily mean the option trader can make more. The capital requirement on those high-priced stocks can be a problem.
The capital requirement on a short put, for example, is based in part on the stock price. The higher the stock price, the larger the required capital to short a put. Is the option trader using their trading capital efficiently if they’re selling high-priced options on high-priced stocks? Not necessarily. If the options on a $50 stock have a higher IV than the options on a $600 stock, the option trader might consider shorting 10 OTM puts on the $50 stock rather than one OTM put on the $600 stock.
In fact, for the same amount of capital required to short an option on a high-priced stock, the trader might consider either trading more contracts of a lower-priced stock with higher volatility or trading fewer contracts, which requires less capital and lets them diversify more.
Looking at volatility from the perspective of trading capital could help you realize that you don’t necessarily have to go after big swings in high-priced stocks.
If stock XYZ’s options have an overall IV of 40%, is that high or low? It’s hard to tell without understanding the volatility range the stock has had in the past. Many traders monitor the VIX (which is a measure of the IV of SPX options) and compare the VIX to the volatility of an individual stock. But if the VIX is 15%, does that mean that 30% volatility in a stock is high? Not necessarily. You need to compare the stock’s current IV to past IV to better judge if it’s high or low.
To help compare volatility, you can look at options statistics and charts on the thinkorswim® platform.
Options statistics. From the Trade tab of a specific stock symbol, scroll down to Today’s Options Statistics (see figure 1). The Current IV Percentile shows you today’s IV compared to the high and low range for the past 12 months. A 50th percentile means IV is exactly in between the high and low values. A percentile closer to 0% means vol is low, and closer to 100% means vol is high relative to where it’s been.
thinkorswim charts. You can pull up an implied volatility chart to see IV on different time frames. From the Charts tab, enter a symbol. At the top right, select Studies, then Add study > All Studies > I-L > ImpVolatility from the menu. You can compare the current IV to its high and low values for short- and long-term ranges.
Check out our wide range of educational resources including articles, videos, an immersive curriculum, webcasts, and in-person events.
Many retail traders routinely use the probability of an option expiring in the money (ITM) or OTM to choose a trading strategy. But are equal probabilities actually equal? The simple way to answer this question is to look at the Analyze or Trade tab on thinkorswim, and from the Layout menu in the Option Chain, display the Probability OTM and Probability ITM.
For example, take two stocks, MNKY and FAHN, both of which are trading at $100. If the MNKY December 95 put has a 70% probability of expiring worthless, and the FAHN December 90 put also has a 70% probability of expiring worthless, that indicates the IV of the FAHN options is higher than the IV of the MNKY options. A higher volatility implies a larger potential percentage price change in the stock price. And the more likely a stock will make a large move, the higher the probability a further OTM strike might be ITM at expiration.(Keep in mind that probability is theoretical and isn’t a guarantee of future performance.)
With a higher volatility, FAHN is more likely to rise or fall 10 points than MNKY. And the market suggests that the price of MNKY may fluctuate less. So, the strike prices that are closer to the current stock price of MNKY may have a higher probability of expiring worthless. In this way, the volatility of different stocks translates into a probability representing the market’s estimate of how large the magnitude of the potential price changes might be in a particular stock.
The volatility of a stock or market doesn’t tell the whole story. Vol needs to be viewed through the practical trading lenses of capital requirements, implied volatility comparisons, and probability. This new set of lenses, along with an understanding of how high or low volatility is relative to where it’s been, may help option traders determine both a volatility that presents a potential trading opportunity and a strategy that aligns with the volatility of a particular stock.
for thinkMoney ®
Financial Communications Society 2016
for Ticker Tape
Content Marketing Awards 2016
Content intended for educational/informational purposes only. Not investment advice, or a recommendation of any security, strategy, or account type.
Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade. Clients must consider all relevant risk factors, including their own personal financial situations, before trading.
Please note that the examples above do not account for transaction costs or dividends. Options orders placed online at TD Ameritrade carry a $0.65 fee per contract. Orders placed by other means will have additional transaction costs.
Probability analysis results are theoretical in nature, not guaranteed, and do not reflect any degree of certainty of an event occurring.
The cash-secured put strategy risks purchasing the corresponding stock at the strike price when the market price of the strike will likely be lower.
The naked put strategy includes a high risk of purchasing the corresponding stock at the strike price when the market price of the stock will likely be lower. Naked options strategies involve the highest amount of risk and are only appropriate for traders with the highest risk tolerance.
Market volatility, volume, and system availability may delay account access and trade executions.
Past performance of a security or strategy does not guarantee future results or success.
Options are not suitable for all investors as the special risks inherent to options trading may expose investors to potentially rapid and substantial losses. Options trading subject to TD Ameritrade review and approval. Please read Characteristics and Risks of Standardized Options before investing in options.
Supporting documentation for any claims, comparisons, statistics, or other technical data will be supplied upon request.
This is not an offer or solicitation in any jurisdiction where we are not authorized to do business or where such offer or solicitation would be contrary to the local laws and regulations of that jurisdiction, including, but not limited to persons residing in Australia, Canada, Hong Kong, Japan, Saudi Arabia, Singapore, UK, and the countries of the European Union.
TD Ameritrade, Inc., member FINRA/SIPC, a subsidiary of The Charles Schwab Corporation. TD Ameritrade is a trademark jointly owned by TD Ameritrade IP Company, Inc. and The Toronto-Dominion Bank. © 2022 Charles Schwab & Co. Inc. All rights reserved.