Hello, my friend, and welcome to this post on Fibonacci Retracement. In this post, we will talk about buying options with low implied volatility and how it can be a huge mistake because low volatility markets don’t move!
I hope you enjoy it!
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Buying Options Implied Volatility – Part 2 – Video
Hey traders! I’m back with part two of this discussion because my first video stirred up some questions and misconceptions. But that’s great—misunderstandings are opportunities to learn! This topic is critical for trading options, and the key idea I want to emphasize is about implied volatility (IV).
The Myth of Low Implied Volatility
Many believe you should buy options when implied volatility is low, and while that’s partially true, the real key is this: You don’t just want low IV—you want it trending upward. Simply buying when IV is low isn’t enough; the trend of IV matters significantly for pricing.
Recap on the Previous Post – Buying Options Implied Volatility
Here’s a recap of what I covered previously: Options are priced based on several factors, including the price of the underlying asset, interest rates, the strike price, days until expiration, and volatility. Today, we’re focusing on the volatility component, specifically IV.
The Importance of Implied Volatility Trends
Some people think that if the price of a stock rises, IV will automatically increase. That’s not always the case. Implied volatility reflects the market’s expectation of future volatility, not the current or past price movements. This is why it’s essential to look at the trend of IV when trading options.
For example, if you’re buying a call or put option, you want IV to be trending upward because it directly impacts the option’s value. Sometimes, the stock price may rise, but the option price doesn’t increase if IV remains flat or drops.
Implied Volatility Behavior Around Earnings
A more informed question I received was about implied volatility changes around earnings. Yes, IV often rises before earnings announcements because the market expects volatility. However, it doesn’t always behave predictably. Sometimes, IV drops as the event approaches or even after the announcement. This variability is why it’s critical to track IV trends independently.
Examples to Illustrate:
- Bearish Scenario with Rising implied volatility:
Suppose you’re bearish on a stock and buy a put option as the stock breaks out of a channel. In this case, implied volatility increases along with the stock’s downward movement, boosting the option’s value. - Bullish Scenario with Falling implied volatility:
Now imagine a stock’s price is rising, but implied volatility is trending downward, possibly due to an upcoming earnings report. In this situation, even though the stock price increases, the drop in implied volatility reduces the option’s value.
These examples show why implied volatility trends are as crucial as stock price movements when deciding to buy options. If implied volatility isn’t trending favorably, it’s best to avoid that trade, even if the stock’s price moves as expected.
Key Takeaways:
- Implied volatility is about expectations for future volatility, not current price trends.
- Track implied volatility trends separately to ensure they align with your trade direction.
- For better results, combine favorable implied volatility trends with price movement.
If you have any questions or thoughts, feel free to share them in the comments!
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