Options Trading and Implied Volatility Analysis: Essential for Traders of Stocks, Gold and Energy

Options Traders with differing levels of knowledge are all willing to trade with risk capital. In order to be an effective Options Trader in the long-run, one must analyze the Implied Volatility of the Options Contracts that they are trading. Implied Volatility is a numerical calculation of the value of an Options Contract. Mathematically speaking, Implied Volatility is the Value of the Volatility of the Option which, when input in an Options Pricing Model, will return a theoretical value equal to the current market price of the option. This enables the trader to compare the value of all Options Contracts by examining the Implied Volatility rather than the Prices of the Options Contracts.

Implied Volatility allows a trader, with a cursory glance, to distinguish between Options Prices. In its simplest use, one can compare the price of a 120 Put with an Implied Volatility of 40% to a 100 Put with an Implied Volatility of 55%. Implied Volatility makes it easy to see that according to the Black-Scholes model, the 100 Put is over-priced. The question remains, is the Implied Volatility meaningful? If the stock is on the last day of trading and the price of the stock is 130, perhaps both options are offered at very small prices and therefore the mathematical calculation of Implied Volatility is meaningless. If, however, there is plenty of time until expiration, then the differential in Implied Volatility provides an easy methodology of analyzing price. The Chart below shows some strike prices with the bid and offer of the option and the Implied Volatility. As one can see, the Implied Volatility is not the same for every strike, but because the progression is somewhat consistent, it is a familiar structure of pricing in Options Markets.

In the example below, there are Options Strike Prices at a 50 Point Differential in the E-mini S&P. While one could review the prices of the Options, that procedure alone would not give them a point of comparison in terms of “value” and/or Implied Volatility. The Option Price, when backed into the Black-Scholes model, provides the Implied Volatility necessary for analyzing Options Pricing. Most importantly, however, it gives the trader the opportunity to analyze and compare Options Prices in order to select an Options Trading Strategy which meets one’s risk/reward requirements. The prices below were taken at Monday’s 4:00 PM ET close. They exemplify comparatively low Implied Volatilities for these Options in comparison to those trading in the last couple of months. The ability to evaluate Options using the Implied Volatility is essential. Would one rather sell a 2000 Put with an Implied Volatility of 15.59% or an 1800 Put with an Implied Volatility with 22.31%? According to the Black-Scholes model, the 1800 Put is over-priced because it has a higher Implied Volatility, unfortunately, the analysis isn’t that simple.  Analyzing the Implied Volatility, in combination with Option Strategies and Skew, enables traders to find positions that meet their goals and risk requirements.

Implied Volatility is a number that provides any trader with a basis of comparison and is an essential tool for evaluating Options Prices. If you’re not taking advantage of this tool, you’re not providing yourself with one of the edges that Options Training can provide. At Options Strategy Network we provide Webinar Training in Trading and Risk Management to assist traders in fine tuning their Options Trading technique:  Contact us  to enhance your understanding of these issues. Our Private Webinar Training Sessions, for a fee of $75/hour, will enhance your options trading. 
 
Once a trader has mastered the understanding of Implied Volatility, they can use it to make comparisons to Historical Volatility and the Implied Volatility Skew. These techniques enable traders to choose Options Trading Strategies which most appropriately meet their risk/reward requirements. If you are Trading Options and don’t understand these concepts, Contact us for an Options Trading Webinar to improve your Trading Technique.

OPTIONS TRADING INVOLVES SIGNIFICANT RISK AND IS NOT SUITABLE FOR EVERY INVESTOR. THE INFORMATION IS OBTAINED FROM SOURCES BELIEVED TO BE RELIABLE, BUT IS IN NO WAY GUARANTEED. PAST RESULTS ARE NOT INDICATIVE OF FUTURE RESULTS.

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