Different volatility numbers tell you different things. Is one more useful than another? Let's find out.
Understand what the different volatility numbers mean
Volatility (vol) values are like clues in a scavenger hunt. Each one might reveal the perceived risk of an option and how that exposure could affect your overall trading strategy.
You know vol is important. But should you look at overall implied vol (IV), the IV of each options expiration, or the IV of each option within an expiration?
Overall IV. Use this as a big-picture metric to get a general sense of where vol is in a specific symbol’s options. You can also use it to compare the vol of one symbol to another.
Overall IV of each expiration. Consider this a blended vol, based on a basket of options within a given expiry.
IV of each option within an expiration. This is the vol input (along with stock price, days to expiration, interest rate, and dividend yield) for a theoretical options-pricing model that makes the theoretical options contract price equal to the market price. If the market, and theoretical price, of an option is $3 with a 25% vol input, that option has a 25% implied vol.
Fire up the thinkorswim® platform from TD Ameritrade. Select the Trade or Analyze tab and enter a stock symbol. You’ll notice different vol numbers (see figure 1). Let’s explore how they’re calculated.
FIGURE 1: WHICH VOL? You’ll find different vol values in the Option Chain on the thinkorswim® platform from TD Ameritrade. You can explore an overall implied vol, the implied vol for each expiration, and implied vol for each option. Chart source: the thinkorswim platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.
These IVs are used to calculate the greeks and probability numbers you see for each option. If you base your strategy on the probability of an option expiring worthless, that probability uses the IV of the option in its formula. If you want to sell a covered call against long stock where the call has a certain delta, say 0.30, that delta uses the IV of the option in its formula.
Individual IVs are also used to calculate the greeks for options positions, which you can find in the Position Statement section of the Monitor tab. When vol changes, those greeks change, too, and they can change your position’s risk exposure. If you beta weight your portfolio, changes in vol can have a compound effect, changing the greeks of your underlying positions and any hedges you have. In a word, pay close attention to IV.
Depending on your trading style, any one of these vol numbers could be more important than the others. But consider all of them for clues so you can get the best sense of where vol exists for a given symbol.
Do Not Sell or Share My Personal Information
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.
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. © 2024 Charles Schwab & Co. Inc. All rights reserved.