After trading in Options for more than 18 years, one of the questions that I see a lot is how should we use IV Percentile and IV Rank to determine if we should buy or sell an options? How do we do guarantee a better returns using IV Percentile? Well, read on to find out.
When Do We Use IV Percentile or IV Rank?
Personally I sell Options when it has a high Implied Volatility (IV percentile), typically higher than 30%. I would buy Options when it is lower than that amount. This is a hard rule but it has worked well for me in terms of the premium obtained.
There are traders who also use IV Rank to do this similar check. However, please do note that there is a difference. We should not use the same number to assess when using IV Rank.
What Is The Difference Between IV Percentile or IV Rank?
Many traders do not understand the difference between the two, but each can give us a very different picture of the volatility environment.
IV Rank is a description of where the current IV lies in comparison to its yearly high and low IV.
IV Percentile tells the percentage of days over the past year, that were below the current IV.
Personally I use IV Percentile so that I can see the comparison across the whole year to see if I should buy or sell the Options.
At Times IVR Can Be Misleading
I search and found the following video by Dr. Data (Michael Rechenthin, PhD) to be the best to describe that difference. He first shows us how to calculate each and explains what they mean. He makes the formulas understandable even for those of us who are math challenged.
He then explains why at times IVR (IV Rank) can be misleading and can keep us from selling premium because we think IV is low.
Dr. Data uses an example to show that sometimes IVR looks low but IV% tells us there is something to sell as most of the time IV is lower than where it currently is (in this example). The graphs he displays, especially the ones of the distribution of IV, make things clearer.
He does a great job of explaining it all. The amount of premium received and return on capital are key measures on which to focus when choosing which measure to use and whether to trade or not.
At End Of The Day, Consistency Is Key
The importance of consistency is stressed. Dr. Data along with Tom and Tony emphasize that picking and choosing when to use IVR and when to use IV% is not smart. What is smart is to know about the different tools available and after watching this segment you will understand IVR better, IV% better, the difference between the two and you will have another from which to choose.
Watch this segment of The Skinny on Options Data Science with Tom Sosnoff, Tony Battista and Dr. Data to learn the difference between IV percentile and IV Rank and what each can tell you.