This
concept is important to grasp, and but it is not as important as ranking IV implied volatility. IV rank is a favorite tool for experienced options traders because it tells us whether implied volatility is on the high end or the low end in a specific stock based on the past year of IV data. If a stock has IV between 30 and 60 over the past year, and IV is currently at 45, it would have a rank of 50%. This concept is starting to become very mainstream as more traders use it to factor in their entry and exit levels. Here is a good example to illustrate this concept. If you were to go out and buy/sell an option in an index like the SPY (the SP 500 index, it would typically have a lower implied volatility than a stock like NFLX. Why is that exactly Sharp increases or decreases in the stocks that makeup that portfolio will not impact the overprice because other stocks will even it all out. Lower price swings
mean lower implied volatility, which ultimately means lower IV rank. So does this mean that sellers will always get a raw deal since IV never really gets that high This is where IV ranks come in Because an underlying stock may not reach a high level of IV, it does not mean that the option will always be cheap.
Remember, pricing is relative. And what is more important is the level of IV relative to its historical levels. Over the past 90 days, SPY has had an implied volatility level around 12 to 13%. The highest level was around 16% in the last 90 days. Typically 16% isn’t considered high
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for most underlying (so one would expect
option prices to be cheap, but relative to where it has been, 16% is high, and the options prices will reflect that.
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