Options are a sure way to diversify your financial portfolio, but without a secure understanding of volatility, novices fail to profit. There is a swing in the market that causes prices and volume to spike. When the spikes aren’t there, you’ll need measurements like volatility to help you.
The implied volatility of an options contract is the range or fluctuation that prices are likely to experience. In an active market, implied volatility has the function of measuring risk. Some investors rely on specific buy and sell strategies depending on high or low volatility. You can predetermine your IV strategy also. Volatility equips you to anticipate how others will behave as the marked prices and dates of your contracts are reached.
Differences Between IV Rank or IV Percentile?
Though both measure IV, rank and percentile give you different perspectives on historical data. Since volatility measures probability, both rank and percentile give you insights into how to position trades or close the ones you have out. Below is a better look:
Your IV rank is derived from a historic comparison made within roughly one year’s time. To find your rank, find the current volatility of the market. Now take your 12-month low and minus that from the current IV. These are the steps that generate the top part of your fractional equation, which is also known as the numerator. Your next steps require division, so to get your denominator, you need to find your IV’s high over 12 months.
Now minus that 12-month high by the previous 12-month low you sustained. Since fractional in design, your IV rank is measured against 100, being the total sum of one. A solution of 39.6, therefore, is equal to 39.6 percent. When evaluating implied volatility as a trading indicator, the higher your percentage is, the closer you become to being currently at your highest ranked IV.
The percentile method of ranking IV calls for you to focus on the number of days your IV closing was found below the recent average. To do this, you start with equating the number of days of below-average IV you had. Since there are only about 252 trading days in a year, this is your denominator. Divide your number of days below-average IV by 252. The resulting solution gives you the percentile of days that your IV rank fell below the current IV.
Most options traders can rely on their broker to do these calculations for them. You’ll find the respective information you need under rank (IVR) and percentile (IVP).
Should You Use IV Rank or IV Percentile?
According to Tastytrade, your decision to use rank versus percentile is based on current levels of volatility. In most cases, it’s best to buy options with low volatility and sell those with high IV.
Since market conditions can drastically change, the data you receive can be distorted as a result. To limit this distortion, options traders follow both IV ranks and percentiles.