When I first started trading options, I really didn’t understand it a whole lot. However, I stuck to it and started to figure out the inner workings of how they work. Now, there’s one factor that I believe many beginner options traders miss — implied volatility.
Today, I want to show you why I believe traders should take into account implied volatility (IV) and the role it plays in options trading.
Those who ignore this may be at the mercy of IV and paying up for options, which is why I believe this is one of the most important factors options traders should consider.
So what’s implied volatility?
The Importance Of Implied Volatility
If you’re going to be trading options, there are a few factors that I believe need to be taken into account. However, I think there’s one crucial element that many options traders ignore when they first get started.
Now, options pros may use implied volatility to actually quote the price of an option.
Implied volatility can be thought of as the amount the market believes the underlying stock will move by. The way it works is a little complicated and there’s a mathematical formula involved, but luckily, options trading platforms typically calculate that for traders.
I like to think of this in simple terms.
If traders buy options (or they’re net long) that means they’re long implied volatility. The options pros like to say they’re long vega, which I’ll explain shortly.
Now, those who sell options (or are net short) would be short implied volatility, or short vega.
Why Options Traders May Want To Focus On Vega
When it comes to implied volatility, there’s one indicator that can tell you how much your options value can theoretically change given the changes in implied volatility. On thinkorswim, you could just change the view to show the greeks.
You should see a value that says vega. With this, it tells us how much the options price will change given a 1% move in the implied volatility. Now, keep in mind that implied volatility and vega will change as the options price changes.
So let’s say the vega value is 0.38, if you’re long an options, then a 1% increase should cause the options price to rise by 0.38. On the other hand, if it drops by 1%, the options price should decrease by 0.38.
Well, when implied volatility is high (like it is for some stocks currently), I want to be a seller of options… and understanding vega will help me figure out how to size my positions. On the other hand, when implied volatility is low, I may take a step back and remain patient.
For me personally, I like to be a seller of implied volatility.
I believe my strategy works great when implied volatility is high… and it can stack the odds in my favor.
You see, I can profit in multiple scenarios, as well as benefit from time decay and benefit from drops in implied volatility (because I’m net short options).
For example, when there’s a lot of volatility in the market, I would look to use this strategy on stocks that move a lot… and I don’t necessarily need the underlying stock to move in my favor.
Now, if you want to learn more about how my options trading strategy works and how I position myself for potential profits with defined risk, then click here to grab a copy of my complimentary eBook, Wall Street Bookie.