Implied volatility is nothing but the volatility for which the options have been priced i.e. if options are priced higher means the street is expecting higher volatility and hence demanding higher premiums and a lower IV means that there is less uncertainty and the premiums demanded are lower.
Leaving the technical definition of Implied volatility(IV) we would like to mention about the practical application and insights that IV can give an options trader, the major benefit of understanding about IV is it helps you in identifying the demand or supply of a particular option.
That means if more people are demanding to buy an option it’s IV tends to increase and if there is more supply than the demand the IV tends to fall.
How important is it to consider IV trend when trading options? well it depends on whether you are a buyer or a seller of an option.
If you are a buyer of an option..
- Look to buy an option in your preferred direction where IV just started to rise.
- Don’t buy an option with IV much higher than it’s usual IV this usually means that the option is priced higher and once the uncertainty fades the IV can crash resulting in much lower option prices irrespective of the direction of the underlying.
If you are an option seller or writer..
- Look to write options with a higher IV to profit from sudden crashes in IV
- Don’t prefer shorting options which are priced at their lowest IV because IV rise can hurt you irrespective of the direction of the instrument.
Being an index option trader, IV can tell you which options are being demanded at current scenario, Do not forget to check out our strike wise Live intraday IV Charts for all the index options to understand the demand and supply in various index option strikes.