How to Trade Options with Implied Volatility: Options are used for various purposes like for generating income, hedging, or expressing a view of the asset class. Options are used by market participants like arbitrageurs, hedgers, and speculators to execute the above purposes.
But options do have some elements that form it as a whole. Options are quoted in premium and that premium is a form of volatility, demand, supply, underlying asset’s move, etc. Today we are going to look at the implied volatility and how it affects option prices.
What is Implied Volatility?
Implied volatility in simple terms is the expected volatility of any underlying asset in the near future and is used as an input to calculate an option premium. Implied volatility has a greater influence on option premium and is positively correlated. Hence if IV increases, the option premium also increases and vice-versa.
Changes in implied volatility are driven by simple demand and supply mechanics and changes in the underlying’s movement. Options with high implied volatility due to various market forces will have high option premiums.
On the contrary, if the demand for options decreases, implied volatility will also react in the same direction.
Trade Options Implied Volatility
Until now it’s clear that implied volatility shows the magnitude of an underlying asset’s potential move but without the direction. For instance, if the IV is high the market interprets it as the underlying has the potential for large moves in any direction, just as a low IV construes the opposite..
With IV traders can plan their trade in an objective way and design entry and exit points. If the trader thinks that the IV of an option is going to be higher then he can materialize on this by executing strategies like Straddle (buy ATM call and put), Strangle (buy OTM call and put) and if the view is otherwise he can execute short straddle or strangle depending on the premiums.
In short, IV helps traders to place their bets efficiently unlike historical volatility which only tells you how the options have been exposed to volatility and cannot guarantee future volatility levels.
Learning Implied Volatility
There are many share market option trading courses offering different content and as an individual, it becomes confusing to choose the right one. Upsurge.club has courses that are dedicated to options trading and implied volatility course that will help you learn more about this concept.
These courses will help you to learn concepts like:
- Understand how to sell options using volatility
- Forecast a range using volatility and many more.
Volatility is an important element in options trading and implied volatility as we learned can give a great edge to any option trader if managed efficiently.