Thread by @asitbaran

As requested, this thread is on IV: The Power of Implied Volatility

IV shows the market’s opinion of the stock’s potential moves, but it doesn’t forecast direction. If the IV is high, the market thinks the stock has potential for large price swings in either direction, just as

2. low IV implies the stock will not move as much by option expiration.

IV can be used to predict whether a market is likely to move higher or lower and it can warn traders against buying options that are too expensive. IV is a powerful tool and if used correctly

3. it will add another dimension to trading and remove the element of guesswork and discretion

Unfortunately, many novice futures and options traders do not factor in IV as part of their trading plan. It is, in effect, a measure of supply and demand for an option. If you measure

4. volatility incorrectly, then you don’t get the right balance of diversification and you have more risk than estimated.

In simple terms, IV is determined by the current price of option contracts on a particular stock or future. It is represented as a % that indicates the

5. annualized expected 1 SD range for the stock based on the option prices. For example, an IV of 25% on a Rs1000 stock would represent a 1SD range of Rs250 over the next year.

In statistics, 1SD is a measurement that encompasses approximately 68.2% of outcomes.

6. When it comes to IV, 1SD means that there is approximately a 68% probability of a stock settling within the expected range as determined by option prices. In the example of a Rs1000 stock with an IV of 25%, it would mean that there is an implied 68% probability

7. that the stock is between Rs750 and Rs1250 in one year.

When the uncertainty related to a stock increases and the option prices are traded to higher prices, IV will increase. This is sometimes referred to as an “IV expansion.”

8. On the opposite side of IV expansion is “IV contraction.” This occurs when the fear and uncertainty related to a stock diminishes. As this happens, the stock’s options decrease in price which results in a decrease in IV.

9. An analogy that will stay forever for IV is knowing

A. HOW MUCH FROTH IS IN THIS GLASS OF BEER?

IV is a measure of the strike price and premium of an option in relation to the underlying price. IV is used to measure a market’s risk — or to simplify things, its “froth”

10. content. Traders will buy options with more froth than beer, and when the froth evaporates, they are left with little or nothing. Unfortunately, this is exactly what most traders go through every day. The return on their investment is zero. Understanding this concept alone'll

11. stop you from buying options that are too expensive (that is, they have too much froth), and second, if you are a futures trader, will allow you to predict the direction of the market.
Professional Writers understand the markets and, by IV (the froth in the glass of beer)

12. A higher IV indicates that the pint of beer has a lot more froth, while a lower IV indicates less froth. This is all you need to understand IV

they ensure the odds are in their favor. Options traders determine their risks using sophisticated models to calculate the IV

13.
B: WHEN A PINT OF BEER IS ALL FROTH

Buying an option with a 100% increase in IV is like buying a pint of froth. It expired worthless. Had you bought the options once the IV had increased by 100% (thinking that prices would continue to rise), you would have lost money.

14. Always remember to check the IV before trading the underlying futures or buying the options.

If you buy an option that is OTM, we only purchase time. If the underlying doesn't become volatile and the froth is not in the beer glass, this option will expire worthless.

15. Hence ~ 80% of options expire worthless

The only way to ensure the odds are in your favor when buying options is to wait for one or two patterns to occur: The first would be a 100% decrease in IV. This would be equal to all of the froth evaporating out of the glass. The

16. second would be what I would refer to as the IV to come up with “opportunist” areas to trade, based upon some Mean Reverting models (Based upon ATR+STOCHA, BB+RSI etc.)

17. Suggested Readings:
Taleb's Dynamic Hedging
Trading IV & Option Volatilty Trading by Volcube Series
Sheldon Natenberg's Option Volatility and Pricing Strategies

Along with the above Tasty Trades' video series on IV will

tastytrade.com/tt/learn/impli…

18. be of immense help as well

Above is summarized version of my understanding and how I look this factor. Feel free to add content to this so that larger audience can benefit.

Next one will try to share an model based upon IV, if its of help and talk about Volatility Skew.