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Implied Volatility (IV), IV Rank and IV Percentile: Defined and Practical Applications

When writing covered calls and selling cash-secured puts, the implied volatility of the underlying securities is directly related to the premiums we receive and also measures the risk we are taking with our option-selling trades. We protect ourselves from using IVs that are too high or too low by defining our initial time-value return goal range and then selecting options that meet these criteria. Recently, there has been interest in 2 IV metrics: IV Rank and IV Percentile. These give an historical perspective of the IV itself. This article will explain the terms and their applications, if any, as they relate to our low-risk option-selling strategies.

 

Definitions

Implied volatility: This is a forecast of the underlying stock’s volatility as implied by the option’s price in the marketplace. It is generally based on a 1-year time-frame and 1 standard deviation (accurate 67% of the time).

IV Rank: Measures IV in relationship to its 1-year high and low. If the current IV is 20% and the 1-year range is 10% – 40%, the IV Rank is 33%. The formula is:

[100 x (current IV – 1-year low)/(1-year high – 1-year low)]. In this hypothetical:

[100 x (20 -10) (40 – 10)] = 33%

IV Percentile: The percentage of days the IV is below current IV in the past 1-year. It does not factor in yearly high and low. If the current IV is 30% and 200 of the past 252 trading days the stock’s IV was below 30%, the IV Percentile is 79.4%. The formula is:

(# days IV is below current level/252). In this hypothetical:

(200/252) = 79.4%

 

IV Rank and Percentile Data can be found in most broker research platforms (Schwab here)

 

IV Rank and Percentile Stats at Schwab

 

General applications

Some option traders will use IV Rank and Percentile to determine which strategies to use. For example, if a stock has an especially high IV Rank or Percentile, a strategy may be selected to take advantage of the mean reversion concept that suggests a return to average. The same holds true for a low rank or percentile.

 

Applications for covered call writing and selling cash-secured puts

I put significant emphasis on implied volatility but little on IV Rank and Percentile. We are undertaking 1-week or 1-month obligations and re-evaluate our bullish assumptions on a frequent basis. We have our initial time-value return goal range in place as well as our buy-to-close limit orders. We have screened the heck out of our stocks from fundamental, technical and common-sense perspective. I submit that adding historical perspective on our options may be a case of analysis/paralysis.

 

Your generous testimonials

Over the years, the BCI community has been incredibly gracious by sending our BCI team email testimonials sharing stories as to what our educational content has meant to their families. Moving forward, we have decided to share some of these testimonials in our blog articles. We will never use a last name unless given permission:

Hi Alan,

I joined your premium membership, read most of your books. I have done 5 stocks covered calls from your weekly list and I have watched and followed your strategy. I have done very well with my first 5 stocks and I want to thank you. I realized a 4.77% gain from my initial investment.

Dinesh

 

Upcoming events

1. AAII Research Triangle NC: Private webinar

April 10,2021 at 10 AM ET

Zoom webinar- details to follow

 

2. Wealth365 Summit: Free webinar

Thursday April 22nd

10 AM ET

Topic: Portfolio Overwriting: Covered Call Writing Long-Term Buy-And-Hold Portfolios

Register for free here

 

Alan speaking at a Money Show event

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Market tone data is now located on page 1 of our premium member stock reports and page 1 of our mid-week ETF reports.

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

16 Responses to “Implied Volatility (IV), IV Rank and IV Percentile: Defined and Practical Applications”

  1. Susan April 3, 2021 3:12 am #

    Alan,

    Do you use a minimum or maximum IV when setting up your trades? Also, do you monitor IV once you enter a trade?

    Thanks,
    Susan

  2. Alan Ellman April 3, 2021 7:07 am #

    Susan,

    IV should be factored into our option-selling decisions. However, we do not need to look up IV stats as they are inherent in our option premium returns.

    First, we must establish an initial time-value return goal range that aligns with with our strategy goals and personal risk-tolerance. For me, it’s 2% – 4% per-month for near-the-money strikes. I use 1% – 2%, in my mother’s more conservative portfolio.

    Use the multiple tab of the BCI Calculators to establish which strike meets our stated goals. The IV of that option is inherent in those strikes.

    The minimum IV will align with the lower end of the range and the maximum IV will align with the higher end of the range.

    In my humble opinion, this approach is effective in that it focuses in on strategy goals and personal risk-tolerance rather than a specific IV stat.

    Alan

  3. Roni April 3, 2021 1:36 pm #

    Alan,
    I agree 100% with your assessment of the subject.

    If IV numbers were significant for placing successful trades, a computer with an IV-related algorithm would be better than human trading methods.

    Roni

    • Dennis April 4, 2021 3:55 am #

      Susan, Roni,

      Before I started with BCI, I used to pick stocks with the highest IVs to get the largest premiums. What a mistake as I kept losing money. Now my portfolio is under control and making money.

      Dennis

      • Roni April 4, 2021 11:22 am #

        Dennis,

        me too; I lost a lot of money until I learned to use the BCI methodology correctly. It is perfect for us, small retail investors.

        I have recovered all my prior losses, and have had positive results in the past 5 years.

        Good luck – Roni

  4. Barry B April 3, 2021 8:32 pm #

    Premium Members,

    This week’s Weekly Stock Screen And Watch List has been uploaded to The Blue Collar Investor Premium Member site and is available for download in the “Reports” section. Look for the report dated 04/02/21.

    Also, be sure to check out the latest BCI Training Videos and “Ask Alan” segments. You can view them at The Blue Collar YouTube Channel. For your convenience, the link to the BCI YouTube Channel is:

    http://www.youtube.com/user/BlueCollarInvestor

    On the front page of the Weekly Stock Report, we now display the Top 10 ETFs, the Top SPDR Sector Funds, and the 4 single Inverse Index Funds. They are sorted using the 1-month performances from the Wednesday night ETF report and the prices from the weekend close.

    Best,

    Barry and The Blue Collar Investor Team

    [email protected]

  5. Gary April 4, 2021 7:28 am #

    Alan,

    Do the 20/10 guidelines apply to high IV stocks as well as normal IV stocks? Let me ask this way. Are we still protected using the 20/10 guidelines for high IV stocks?

    Thanks,
    Gary

    • Alan Ellman April 5, 2021 9:34 am #

      Gary,

      Yes. High IV securities tend to also represent high Delta securities. This means that, as share price declines for high Delta securities, the premium price will decline quicker to the 20%/10% thresholds.

      This is an excellent question and I will give consideration to writing a more detailed article or produce a video on this topic.

      Alan

  6. Michael April 4, 2021 3:14 pm #

    Hey Alan,

    Love your videos and explanations. I’m having a hard time getting my brain to comprehend something. For Calls or Puts, if you’re buying an in ITM call (or Put) would being the seller make you OTM ?

    Thanks,
    Michael

    • Alan Ellman April 5, 2021 9:38 am #

      Michael,

      Yes, this can be a bit confusing. The “moneyness” of an option (in-the-money, at-the-money or out-of-the-money) is the same for both buyers and sellers.

      Let’s say a stock is trading at $28.00 and the $30.00 out-of-the-money call option has a bid-ask spread of $1.00 – $1.10. The option can be purchased for $1.10 or sold for $1.00. In both cases the $30.00 call option is out-of-the-money.

      Alan

  7. Cary April 6, 2021 5:17 pm #

    Alan,

    My name is Cary. I’m a subscriber to your Youtube channel. I’ve watched 40-50 hours of your videos. Thank you very much for all you do.

    I’ve been trading options for 10 years (mostly call options & credit spreads) When I started, I read 5 books on options & was intrigued with CC’s but never traded them until now when I found you. I just retired & I’m looking to be a little more conservative.

    I’m going to join your service by the end of this week & I have a question.

    Question-When you initiate your cc trade, am I understanding you correctly that you immediately place a btc order at 20% of the option premium price & adjust it to 10% in the 2nd half of the monthly cycle?

    Thank you for your time,

    Cary

    • Alan Ellman April 7, 2021 5:57 am #

      Cary,

      Yes. This creates a guideline as when to close the short call and to then mitigate losses, or turn losses into gains. The 20%/10% guidelines partially automates the exit strategy process.

      Alan

  8. Alan Ellman April 7, 2021 7:14 am #

    Saturday’s free webinar:

    9:45 AM ET

    The Put-Call-Put Strategy

    https://us02web.zoom.us/webinar/register/WN_MVZT905sTEWzI8x4v5jhxg

    Alan will do the power point presentation while Barry responds to chat box questions.

    Alan & Barry

  9. Alan Ellman April 7, 2021 5:01 pm #

    Premium members:

    This week’s ETF report has been uploaded to your member site.

    You will notice that the number of securities that has out-performed the S&P 500 in 1 and 3-month timeframes is greatly reduced from our typical reports. This reflects an uncertain and narrowing market.

    After screening hundreds of ETFs only seven that meet our liquidity requirements have beaten the market in both timeframes. The BCI team found them for you.

    For your convenience, here is the link to login to the premium site:

    https://www.thebluecollarinvestor.com/member/login.php

    NOT A PREMIUM MEMBER? Check out this link:

    https://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  10. Donna April 9, 2021 1:53 am #

    Dear Alan;

    1) I am looking at exiting my XLF April 16 strike 34 cc and instead buying the XLI and selling the April 16 strike 99

    I bought the XLF at 33.73 and sold the 34 cc for .65. The price of XLF is now 34.75 and the cost to close the 34 strike is .93 -.79 = .14.

    The cost to buy the XLI is 99.40 and the premium for the April 16 99 call is 1.16 -.14 yields a 1% gain with only 8 days left.

    The Encyclopedia of CC writing suggests that this kind of strategy should be employed when there are 2 weeks remaining in the contract cycle. Is there some inherent risk i am not considering in my strategy? The XLF is not on the current top performing ETF’s and XLI is.

    2) The Encycopedia of CC Writing says that the risk selling puts is not the same as selling Covered calls and does not recommend this to BCI’s. What has chained in your strategy recommendations now? Is it that the put selling is based on lower deltas. But does that not reduce the returns to only 10% per annum?

    The last BCI report with only 7 ETF recommendations has me frightened. Do I need to switch my strategy of CC writing to put selling and lower my expectation for returns?

    Thank you

    Donna

    • Alan Ellman April 9, 2021 7:17 am #

      Donna,

      I can tell your motivation and due-diligence is paying off. Without giving specific financial advice, let me make some comments you should find useful:

      1.You will notice that nearly all parameters set up in the BCI methodology are framed as “guidelines”, not rules (earnings report rule is an exception).

      2. This holds true for the mid-contract unwind (MCU) exit strategy and its application in the first half of a contract. I have published articles where I used this strategy as late as the last day of a contract when market conditions are highly volatile.

      3. MCU should be considered when we can generate 1% or more than the time-value cost-to-close by expiration in a new trade.

      4. My go-to strategy is covered call writing but selling cash-secured puts is an absolutely fabulous strategy as well. I tend to sell puts in more challenging market environments where I sell puts to either generate cash flow or to enter a covered call trade. I am hosting a seminar on this strategy tomorrow and you can register for free here:

      https://us02web.zoom.us/webinar/register/WN_MVZT905sTEWzI8x4v5jhxg

      5. Delta is not the basis of our strike selection with one special exception I will mention in #6. Our basis is initial time-value return goal range, “moneyness” decisions based on overall market assessment and personal risk-tolerance.

      6. I did develop a low-risk put-selling strategy as a result of the COVID crisis in a low interest-rate environment where I use weekly Deltas < 10. I am still using this strategy in one of my smaller portfolios to this day with outstanding success. Here is a link to an article I published on this topic: https://www.thebluecollarinvestor.com/selling-deep-otm-cash-secured-puts-with-exit-strategy-enhancements/

      Let me reiterate that with our traditional covered call writing and put-selling strategies, our basis for strike selection is not Delta but rather the parameters I mentioned above.

      7. ETFs tend to generate lower returns, but call and put selling returns should be expected to be similar. When we sell OTM covered calls, we also have the opportunity for additional returns from share appreciation up to the OTM strike price.

      Keep up the good work.

      Alan

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