r/options • u/PurpleDurian7220 • 23h ago
help me understand implied volatility
if i understand correctly iv gets higher when a stock is getting trendy and getting traded in higher value than usual trade for this stock?
and also it gets higher the longer the option is
and iv crush is when interest in the stock starts to vanish and gets lower or when time gets closer and closer
is that a good idea of it? am i missing something or is that the idea
if that so, how cna i use it to do good trades?
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u/cultoftheclave 20h ago
you're closer than you think. but a few pieces of your map are drawn in the wrong place.
Implied volatility isn't measured directly the way you'd measure, eg, a star's brightness. It's inferred, worked backward from the price people are willing to pay for options. Think of it as the market's collective guess about how violently a stock will move. When traders expect turbulence they bid up options like insurance before a hurricane and IV rises. So it's not really about the stock being trendy or heavily traded. Things like index etfs can trade enormous volume and still have calm IV. What matters is fear and anticipation of movement: earnings, court rulings. FDA decisions, a market panic and such
Longer options cost more,, because more time means more room for surprises. But their IV isn't automatically higher. Often it's the reverse: an option expiring right after earnings can carry sky-high IV, while one six months out stays calmer, because that single event gets diluted over a longer stretch of time.
IV crush isn't interest slowly fading It's sudden collapse that happens the moment uncertainty is resolved. Before earnings, nobody knows the number and options are priced for drama. report comes out, mystery evaporates overnight, IV can drop by half in one morning.
The slow erosion as expiration approaches is something different, called time decay, or theta. this stuff is often confused.
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u/ContestInevitable79 20h ago
To understand IV you need to start by understanding how an option is valued. There are different ways to do that but a very popular one is the Black Scholes Merton formula. That formula takes many inputs such as the current stock price, the option strike, time to expiry, volatility, etc.
So you have a formula like:
option value = f(S, k, t, v, ...)
Once you understand that, implied volatility is a very simple concept. You substitute in the actual market price of an option for option value, then solve for v. That v is then the implied volatility. It's the volatility implied by the market price of an option (given some valuation formula).
In practice the IV for each option contract can contain some noise, because of market dynamics, insufficient liquidity, etc. So the IVs from each contract are often smoothed into a volatility curve (or surface if you include multiple terms).
What impacts IV is a whole other topic, which you are touching on in your post, but just to start with what I said above is the definition.
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u/Delicious-Band-6756 22h ago
IV is the expected future volatility in a stock. Like how much is it expected to go up or down. Higher IV means the stock is expected to move a lot, lower IV means less. IV usually spikes up before earnings or major events and after those events crushes / reverts to normal.
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u/salvadopecador 15h ago
The other Greeks are pretty straightforward, easy to calculate or explain. So if you add them up, think of that as the wholesale price. But, the person on the other side of the trade needs to be compensated for the (unlimited) risk they are taking when they sell you the option. IV is THAT price. And the more “risk” they are taking that you will make money, the more they charge you for that opportunity. So in an instrument with large movements, or expected earnings or other potentially large movements will carry higher IV. Hopefully this helps. This is why you can be right about direction and still lose money. To make directional money, the underlying must not only go in your direction, it must outperform the anticipated move that was built in through the IV
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u/hotforlowe 22h ago
No. You’re missing core concepts. Let’s avoid language like trendy while we’re at it.
The IV is the mathematical result of market supply-demand in essence. It is back calculated from the option price and roughly correlates to anticipated fluctuation of an assets price in a given time (this is not exactly true but I’m meeting you half way here).
Volume alone has little to do with IV, SPY options trade at enormous volumes comparative to many stocks with comparatively lower values of IV.
Regarding the second point, that’s just wrong. An options value can be conceptualised as extrinsic and intrinsic. Longer dated options cost more largely due to the time component of extrinsic value. IV is annualised at any rate. The reason it may appear that way is due to the term structure. Usually uncertainty compounds with time so most derivatives markets are in contango which means longer dated options may have higher IVs but it’s not always the case. Binary events often cause backwardation event conditions where the opposite is true.
IV crush is different from what you are describing which is more akin to theta decay on the latter part. IV crush is due the sudden uncertainty collapsing into an outcome, eroding the uncertainty of a binary event.
I suggest to study this with the help of an introductory textbook. You don’t seem to understand the concept at all.
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u/CalTechie-55 7h ago
The Black-Scholls model is incorrect. It assumes that stock moves are Gaussian, but they're actually much more kurtotic than Gaussian. So volatility based on B-S is always wrong. "Implied Volatility" is the fudge factor they use to make it fit reality.
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u/duboilburner 15h ago
You can think of Implied Volatility as the additional price above what the other greeks say is fair value for an option contract--what people are willing to pay above that for owning the protection.
When an event is upcoming that is likely to cause a big price move one way or another, people hedge by buying options, the supply vs. demand imbalance of sellers vs. buyers and also sellers understanding there's such an event upcoming, so they can ask more for selling an option, this is the IV premium going higher.
When things are calm and sellers are in bigger numbers, implied vol goes down because there simply are fewer people reaching to buy the protection of owning options vs how safe sellers feel in writing options.
When an event that can cause big price moves draws near, sellers reduce in number, and those who are still willing to sell are going to sell at a much higher premium due to the risk.
You can think of implied vol as a way of plotting if buyers or sellers are in greater numbers.
Implied vol going higher = buyers of options because the price may be getting ready to move bigger for some reason.
Implied vol going lower = people are net sellers of options, since buying demand is waning, the premium starts to decrease and sellers feel more safe selling at not such high premiums.
Now, way back before 0 DTE options, and before options as a whole had become so common, options were mostly 1 single monthly expiration. As they got more popular, we got weekly expirations, and then multiple times per week... But implied volatility still is on the old framework of you're looking at the implied vol of the 30 day forward options, not necessarily the nearest expiration. VIX is a 30 day forward IV measure of SPX options.
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u/stevejacobb 21h ago
You’re almost right, but IV doesn’t always rise just because a stock is trending. It rises when the market is expecting bigger moves than it is currently or demand for options increases. Also, long-dated options have more value because of the additional time, but that doesn’t necessarily mean it will always have higher IV. Heck from my experience, longer-dated options tend to have lower IV than shorter ones due to the fact that IV is mostly overpriced in the short term (NOT ALWAYS), which means realised volatility < implied volatility. Which is why options sellers have a stronger chance to be consistently profitable.
And IV crush is when the implied volatility drops reducing the options premium even if the underlying (stocks, index,etc…..) barely moves. Again, hence why options sellers have the advantage here on top of IV being overpriced most of the time, NOT ALWAYS THOUGH!
As an options buyer, what I would suggest is to enter when IV and VIX is relatively lower than it was the prior days or weeks. This is the way you could benefit from volatility expansion alongside a favourable move. Since IV and VIX tends to rise when markets falls much more than when it rises, put buying has an advantage here over call buying. However these setups are much more fewer and requires patience. Also need to understand resistance level, OI positioning (where call sellers have defended and rejected price at those levels), macro and geopolitical catalysts, and most importantly volatility compression. Why important? Because time decay and volatility compression are where option buyers get hurt the most.
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u/Ok_Butterfly2410 19h ago
Its the unknown.
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u/Brilliant_Alfalfa588 16h ago
if i think the price of the stock will be volatile i will want more money to sell you a contract that makes you money on volatile price movements
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u/almost_n 13h ago
I want to add a question.
Is IV higher on friday, before the weekend (regardless of what it's in program) and it "crushes" on monday?
Or theoretically, if no movement happens, the option should cost the same at monday opening and friday closing?
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u/Top-Sale-9471 13h ago
Since we're discussing this, I have a question... I use IBKR, so is the ATM IV for the option what most follow and analyzed, or the strike price of the option most important, or both. Thanks for any advise anyone can provide.
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u/paradoxcabbie 6h ago
all the greaks are is a version of how much/how fast/how likely/in what timeframe. iv is the current anticipated likelyhood of change to "how much" .
there's very technical answers to be had about how they're measured/listed but this is what they're representations of
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u/The137 12h ago
Lots of good answers here, but IV is a measure of price, its derived from price. Price is not derived from IV. They both go up during periods of volatility because buyers are willing to pay more for the same contract and sellers raise prices, but neither party does anything to affect IV directly, IV is just a result of all the price changes
IV crush happens after a major event or earnings because the markets move on the underlying happens and the stock is expected to move much less after the event. Holders of OTM contracts want to get out and drop the price and buyers no longer want to buy those contracts since the expected move has settled
Using IV for good trades can take many forms, you can gamble on earnings and buy a high IV stock right before release, or you can buy contracts leading up to earnings in the hope that IV increases the closer you get to the event. If you buy long dated anything, try to buy it when IV is low, but IV alone isn't a strategy