Lets see what you got dawg
kiss the game good bye
Hi, I’m Rachel, and this is Step Up to Options, where you learn the long and short of trading options
We just learned that before we even enter a trade, we look for high liquidity because we want to enter and exit our trades at the prices we like
There’s another really important pre-game checklist as well, and that’s volatility
We’ll cover two different kinds of volatility in this video
and then we’ll discover a shortcut that saves us the trouble of getting an advanced calculus degree
Where liquidity has to do with how much trading activity there is
volatility’s just an indication of how far and how often prices move
Think about the difference in how movie ticket prices and plane ticket
Movie tickets might go up a little bit every once in a while, but, for the most part, movies usually cost about the same as the last time you went
Plane tickets, though, bounce around a lot. If you’ve ever booked one online, you know how much can affect them
There’s fuel prices, how far out your flight is, how full the flight is, holidays…all kinds of stuff
The movie tickets have lower volatility because their prices don’t move around that much over a given amount of time
Plane tickets, though, have higher volatility because their prices move farther up and down more quickly
Volatility’s not about the overall direction; it’s about the groove of the moves
Now, traders use two kinds of volatility: historical and implied
Historical is pretty simple. It looks back at the past year and figures out how much stock prices have changed on a daily basis
Ryan’s going to take us through an imaginary stock as an example
Hey
Let’s say that XYZ is a stock trading at $50 today
Let’s also say that it was trading at $50 a year ago too
If the stock only moved up or down by a little bit during that year, say a few cents a day, then the historical volatility might be considered low
Now remember I said volatility didn’t have much to do with overall price trends. So check this out
XYZ was trading at $50 a year ago and is trading at $50 again today
In this example, though, the prices move farther apart, maybe several dollars a day
Even though the stock is trading at the same price as a year ago, it moved a lot on a daily basis
and that’s when historical volatility might be considered high
What about when the stock is trading a different price today than a year ago?
Now XYZ is trading at $100 today
Even though the stock doubled in price over a year, that doesn’t necessarily tell us anything about its day-to-day volatility
It could have been high, or it could have been low
So, if the stock’s going to ended up at the same price regardless of volatility, then what difference does it make now?
To us, not much
Historical volatility is just a reference into the past, if we’re curious
Instead, we’re more interested in implied volatility
Long story short, IV is the market’s mathematical estimation of how much a stock will move in the future
Since options trading is about making short-term predictions
implied volatility is one of the most important things we use to figure out how likely winning is
Now back to Ryan for how IV relates to option prices
Implied volatility relates to option prices in that if one goes up, the other goes up
and the more prices move, the more uncertainty there is in the market
And since options work off of that uncertainty, option prices are higher when Implied Volatility is higher
so what’s really useful is comparing where the current level of implied volatility is to where it has been
And that’s how we can get a gauge on how high the option price truly is
and whether the price is high or low determines whether we want to buy or sell to open our trade
Thanks, Ryan!
so what that really means is that, as option sellers, we collect more when IV is high because prices are high
and we pay less to buy options when IV is low because prices are low
So, are you guys ready to learn how do a bunch of calculus for IV every time you trade?
No? Good! Because you don’t ever have to!
We have an awesome shortcut we can check, a single number that tells us what we want to know, and it’s called IV Rank
Knowing how to use it is much more important than knowing how it’s calculated
dough gives us IV Rank by doing what Ryan was talking about
comparing current implied volatility to its own range over the past year
We see IV Rank as a number between 0 and 100
Regardless of what the actual IV value are
Zero IVR corresponds to the lowest point IV has been over the past year
and 100 IVR corresponds to the highest point
having a consistent scale gives us context for IV and option prices
Here’s an example. If IV has been between 30% and 60% in the past year
and right now it’s at 45%...IV Rank would be 50
Because 45% is the halfway point between 30% and 60%
If IV Rank is above 50, we’d consider IV, and the option price, higher
If it’s below 50, we’d consider both lower
If you’re curious about all the crazy math that goes into calculating IV and option prices
tastytrade has lots of other videos about the Black-Scholes formula and other pricing models
Okay, so we took the long way around to get to the IV Rank shortcut because we needed to know some basic things about volatility in general
It’s all going to come in handy the farther we go because we talk about volatility a lot here at tastytrade
Vol kind of makes the option world go round. So what did we learn?
One, volatility is how far and how fast prices move
Two different kinds of volatility are historical and implied
Historical volatility shows us how stock prices moved over the past year
Implied volatility, or IV, is a speculation on how volatile the stock will be in the future
the IV Rank is a shortcut we look at to know whether current IV is high or low, based on its past
High IV Rank means higher option prices, and, of course, higher option prices mean option sellers collect more
So now that we know we look for liquidity and IV Rank before we place our trades
let’s go through the rest of the pre-game checklist in the next video
And, of course, you can learn more at tastytrade and dough.com
Well here we are again. Look at how far you've come. I am so proud
Anyway keep on going, watch the next video. You are doing great
you can also re-watch this video if you want to go over these concepts or start back up at the beginning if you want. That can always help a lot
It's just what ever you want to do people. It's all up to you
I mean I can't tell you what to do, I mean I guess I could but I wouldn't. I trust you