Hey, what's up everyone? This is Kirk here again, and today we are going to talk about implied volatility. And so today we're going to be doing an in-depth discussion and a little workshop, if you will, on implied volatility.
This is a topic that I think is critical to your success trading options. And so we're going to go here for a little bit and talk really in depth about it, cover a lot of different topics. Some of the things that we're going to talk about here real quick, just so you... you guys know.
First, we're going to talk like what is implied volatility? Basically, you know, how do you calculate it? You know, where does it come from? And the second thing that we're going to talk about is determining our edge. So why is implied volatility so important to trading?
And then third thing that we're really going to cover here is IV rank. So basically, how can we find implied volatility that's high? How do we know? How is it relative, et cetera?
So as you guys are going through this today, if you're watching recorded, just let me know, ask some questions, but be sure I'll get to a lot of the probably questions that you guys get or that I get a lot on this. So I'm sure if you guys have a question, we might kind of cover it here. So the first thing that we have to understand is basically like, what is implied volatility and why is it so important? And we'll probably go through a lot of pieces of paper here today on the workshop.
But the thing you have to understand is that when you're trading stocks, right, this is the difference between stocks and options, right? When you're trading stocks, everything is pretty much. known in the company, right?
Like all information is publicly known and you buy or sell the stock at a predetermined price and you can theoretically hold it forever, right? So I don't know, that's a really bad forever symbol. What's that forever symbol like that, right?
So you can theoretically hold the stock forever. There's no timeline. You buy the stock at whatever price that stock is trading at the time and you can hold it for forever.
So 10 years, 20 years, whatever the case is. And so all of the company expectation is baked into the current stock price. How far you think that the stock might go, how much earnings might grow, how much their profit margin might expand or not, that's all baked into the stock price already.
That's why sometimes you see even like recently last week, Facebook had earnings. They had really great earnings, but what actually happened is that the stock went down because they didn't grow as fast as companies, as people expected, right? But all that's baked into the stock price automatically.
The difference is that with options, you have two additional components that you have to deal with, right? The first major component is time. So what happens with option contracts is that you have this time component that you have to work within, which means that the contracts have a finite life. They expire at the end of the week or the month or the year. And so that creates a little bit of alarm for how you should price them.
Like, how do you value something that theoretically has much shorter time? Like, what's the difference between valuing A contracts that have 10 days to go versus those that have 30 days to go. And within this component then, the major ingredient or basically the major factor that we help determine pricing is implied volatility. Okay?
And implied volatility or IV for short basically just answers the question, how far do traders expect the stock to move? to move? I don't know if that's all on the screen. Maybe it is, right?
But there it is. That's the answer. That's basically what IV does is it basically says, okay, how far do traders expect the stock to move?
Now, the key here is that this expectation is for the future. So how far do traders expect the stock to move in say, let's say the next 30 days or the next 90 days or the next two years, right? What is that expectation?
How do we determine that? And that's what I implied volatility does. Now, basically, in very simple terms, how you would figure out this implied volatility, and so I'm just kind of moving the sheet around, so don't get seasick on me here. But basically, what you want to do is you generally want to look at the money and slightly out of the money options. Okay, that's how we determine.
And it's based on how aggressive people are buying those options or not, right? people, actual traders, actual market participants are really, really buying options aggressively, meaning they're willing to pay, let's say $10 for an at the money call or put versus paying, let's say $2 for an at the money call or put. Well, that means that if they're more aggressively buying those options, they expect that the stock is going to make a big move in either direction because it covers that difference. If a stock is trading at let's say $50 and I'm willing to pay $10 for an add the money option, that means that the stock really has to trade between 40 and 60 for me or outside of 40 and 60 for me to make money. So I'm assuming I'm an option buyer here.
Okay, so an option buyer has to trade outside of 40 or 60. Now, if I'm willing to pay $10 for a 50 strike option, call or put, it doesn't matter, then I know that it's or I'm expecting it to trade outside of $40 or $60 before I make money, then I have through my actions, and this is the key here, through my actions, I have determined basically how far I expect the stock to move in the future. By the fact that I am actively willing to pay $10 for that contract, I have through my actions determined how far I expect the stock to how far I expect the stock to move into the future. Now, counteract this with somebody, let's say, let me just move my sheet up here a little bit.
Cognizant and trees here at Option Office, we don't want to use up all the sheet. But let's say the stock is trading at $50, but I'm only willing to pay $2, or let's say all traders are only willing to pay $2, then I have through my actions implied that the range I think that the stock is going to trade between is 48 and 60, I'm sorry, 52, okay? So through my actions, again, because I either aggressively bought options, paying $10 for at-the-money strikes or very close to at-the-money strikes, or if I've paid $2 for those contracts, through my actions, I have determined how far I expect the stock to either move or not in the future. Okay, so everyone on board here with me at this point.
So I just want to know, if you guys are joining in here live, I'd love to know. Okay, so that's basically what we do. So it's all through market participants.
Market participants determine how far the stock might move in the future or how far they expect the stock to move into the future. Now, look, this expectation thing has a lot of things baked into it, right? It could be earnings are coming up, a major drug announcement.
I mean, there's so many things that are baked into it. But what you have to understand is that the more people who are actively determining this, this number right here, right? What is the active participation of the market? Are people really, really actively buying and paying aggressive numbers or are they not? That determines how far people expect the stock to move into the future.
So is everyone on the same page here? And I'm just keep looking at my notes. So I'm making sure that we're all going into this. Now look, this obviously has a lot to do with option pricing. So when implied volatility, and this is what you'll generally see.
So let me just do this. We'll come over here and kind of move over here a little bit. When implied volatility is high, that means that people are willing to pay more money. for an option contract because they expect a bigger percentage move in the underlying stock.
Now this could be up or down, but when implied volatility is high and people are willing to pay more money per contract, that means that they expect a higher percentage move up or down in the stock. When implied volatility is low, then people are not willing to pay a lot of money because they don't really expect the stock to go anywhere. I pay a lot of money for an at-the-money strike if you don't really expect the stock to go anywhere, then people expect the percentage of movement in the stock to be low, right? Does that make sense how we're kind of going through this?
Okay, so it's very logical the process. If it's high, people are paying a lot of money, they expect a big, big move in the stock. If it's low, people are not paying a lot of money, they expect a low, low, low move in the stock, okay? Now, how we basically transition this over is now we have to basically take this implied volatility number. that we can see in the market and we have to translate it basically into an expected range.
Now this is the really cool thing about it, okay, is that we can take this number that people determine and we can populate it into an expected range. Let me just find where my cursor is here. So let's say the stock is trading, whatever the case is, right? And let's say the stock is now trading at $50, okay? I love using $50, it's just easy to understand.
So At this point, we can then calculate, again, how much people are buying those at-the-money strikes or close to at-the-money strikes are. Let's say in doing that, we have determined that there is basically about a 20% implied volatility reading on the actual stock right now. Based on current market participation, the implied volatility reading is 20%.
Now, this is the actual number. That's the actual IV number, not IV rank. We'll talk about that here in a second.
With this number, we can then determine what's called an expected range or standard deviation range. It just comes from mathematics and probabilities and stats. We take this number and we say, okay, if that's what people are willing to pay in premium, then we can back into an expected range.
And basically what we would do is we would say, okay, the expected range moving forward based on implied volatility of 20% is basically between $60 on the high end. and $40 on the low end. Now, how do we get this? 20% of $50 is 10 bucks. Okay.
So now you have, how you calculate it, just took 20% of $50 is 10 bucks. And then I add or subtract $10 from the stock price. So my expected range. in where the stock might trade for whatever the time period is that we're looking at, daily, weekly, monthly, yearly, whatever the case is, that expected range is roughly between 60 and 40, right? Now you have to do some calculations to figure out the one day, one week, et cetera.
So it's a little bit more complicated than this. I'm trying to simplify it so you guys get to understand like just the general picture and the thought process behind it, okay? So we have tutorials on how to calculate it exactly.
So you got to do use some square roots and stuff like that. But generally speaking, it's this kind of mentality that we're going for. Now, this range then basically encompasses a 68% probability range. Okay. So now we know if a stock is trading at $50 and implied volatility is 20%, then this range should be into the future to expiration between 68% of the time it's going to trade between 60 and $40.
Now, if you guys really understand that and that concept is driven home, like Do you understand how powerful that is? This concept that we can take like raw numbers in the market, actual market participation, and determine this expected probability range into the future. If I'm looking at a stock for $50 and if I know IV is 20, there's a 68% chance that it trades between 60 and 40 into the future, right?
You don't have to look at support and resistance or chart patterns or anything like that to determine this range. And this is powerful for us because now we can develop strategies around this. that basically profit from this range.
Okay? Now, here's where we start kind of transitioning. I just want to ask anyone on the live stream right now, just if you have any questions, let me know.
If you're watching this video later on, not live, just let me know. And obviously, if you're liking it, give it a thumbs up, share it. So another thing that we're going to do now is we're going to talk about edge. Okay? Because I think that this is pretty easy, right?
Is that we kind of understand where implied volatility is at this point. Hopefully, you do. Hopefully, we've done a good job explaining it. Now, we have to talk about our edge. I think this is where...
I guess the rubber meets the road and kind of determine this. Now, what I first want to do here is just talk about insurance companies. And I know probably some of you guys are going to be like, why are we talking about insurance companies?
But it's really important actually, we kind of talk about it. It's an easy segue into how this edge works out in our favor. So with insurance companies, let's say with life insurance, you guys still with me there? Got a call real quick, so I had to end that. So insurance companies have actuaries and what they do is they basically...
My wife is laughing at me right now, but what was I going to do? Somebody tried to call in. I had to end the call, you know?
Well, I did. I had to end the call. All right.
So look, insurance companies have actuaries and they basically determine what your likelihood is that you might die. And look, I don't want anybody to die. I love you guys all. But let's say that the probability of me dying based on my age, my height, weight, you know, medical history, everything. Let's say the probability of me dying is, I don't know, 1%.
Okay. So 1% is the probability of me dying. Let's say the probability of the next person dying, right, is, I don't know, let's say 2% because they eat at McDonald's every day and they don't work out and they have, you know, bad medical history, whatever the case is, right?
Insurance companies can figure these numbers out based on lots of people that they, you know, track and all the measurements, right? Now, if the probability of me dying is 1%, they know that upfront, there is a chance, right? There is a chance. right up front that the day after they issue a policy to me, I could unfortunately die, right? We all know that.
Or I could live forever. I could live much longer than they expect, or I could die literally the next day. If I die literally the next day, then they have to pay a ton of money out to my family and life insurance, right?
Now, I may only pay, let's say, $10 a month or something like that, you know, like 10 bucks a month for a policy, you know, some number. It doesn't matter. But I'm going to pay this number forever until I die or until the contract is up. And then they have to pay out when I die. Same thing for this guy, right?
He could die the next day and then they have to pay out. But because he's got a higher chance of potentially dying, maybe heart disease or medical history, again, something, you know, weight, age, whatever it is, instead of him paying $10 a month, he might actually pay $20 a month. Okay.
So he might pay $20 a month versus my 10. Again, at the end of the day, we may both. the insurance company may pay the same amount to our family if we end up dying. Now, here's the difference, right? Here's how insurance companies make money. They know all of these numbers generally for lots of people.
And they know that they have risks that one person dies tomorrow or another person dies tomorrow, right? That people are going to die and then people are going to live longer than expected. But generally, they have a pretty good idea of what your life expectancy is based on the number of questions that they ask in your medical history. What insurance companies do though, is they charge... what's called a premium over and above what your life expectancy is.
So instead of assuming that you really die 1% of the time, so in my case, let's say that I die 1% of the time in real life, in real life, but like on real actuary tables, someone in my position dies 1% of the time before they hit 90 or whatever the case is. Instead of charging me like I'm going to die 1%, they actually assume some margin or markup and they say, okay, We're going to charge Kirk like he actually dies 2% of the time more than he does on average. So a guy like Kirk, we're going to assume he dies 2% more of the time, percent of the time on average than he really would. So they are overestimating the probability of me dying and they base the premium that they charge me based on this over expectation. Does that make sense how we're going through this?
If you guys are following along in the last... live stream just let me know add a comment real quick i just want to make sure we're all good Okay. So they overcharge based on some premium, some predetermined kind of top end, right? Robert says this recorded. Yes.
Yep. It is recorded. Okay, good. Getting a bunch of thumbs ups, which is good. So they overcharge.
So instead of charging me maybe $10, maybe they charge me like $25. I mean, something like really crazy. It may not be really crazy.
I'm just using this as an example, but they charge me some other premium because they know long-term. Even if I die tomorrow and people like me die tomorrow and they still have to pay out this huge amount of money in life insurance, they're still collecting more money than the actual value or the actual probability of me dying, right? Okay?
So they're still collecting a lot of premium that more than covers the likelihood that I actually die, okay? So this over-expectation that they bake into their pricing is huge. And look, insurance companies do this across the board with everything.
Okay. Across the board with everything. So here's what they do.
Like cars, for example, they have a higher percentage chance of accidents of, you know, of getting into a wreck. Insurance, life insurance, right. Has a higher percentage chance of death, right.
You know, business insurance. I mean, like it doesn't matter, right. It all has, they bake into it a higher percentage of you failing, wrecking your car, dying, getting disability, whatever the case is. then actually happens because they know long term, if they do that, then the odds play out or the numbers play out in their favor. And by the way, it's just like casinos, right? Like casinos, I always talk about casinos.
Casinos bake into their games an edge that only plays out over lots of plays, rolls, whatever you want to call it. They bake in that edge and that edge is different for different scenarios, okay? So they know they could lose right away and they could pay somebody out, but they don't care. They pay them out and then they keep playing. right?
They just have the next person right behind them. By the way, Warren Buffett is one of the biggest insurance advocates in basically in the country. He's got like Geico and all of his insurance companies.
This is why he likes this model because he can charge a premium on top of that. And oh, by the way, again, Warren Buffett is also the biggest options trader in the country. He trades about $5 billion. That's with a B of short option contracts for this reason.
Okay. The same principle that we're talking about here. All right, so we kind of talked about insurance companies.
Let's transition this over to options trading. Okay, why is this so important to options trading? Well, let's take that stock that was trading at $50, right?
And the expected range, I'm going to make this really wide, the expected range, remember, was between 60 and 40. Hopefully you guys can see this on the screen here, but that expected range was between 60 and 40. So now we know upfront at the time that we enter the contract, this option contract. expecting the stock to move between 60 and 40, let's say maybe this contract costs us, I don't know, $3. I'm just using numbers to make it easy.
Okay. So let's say this contract costs us $3, but the expected range is between 60 and 40. Well, now what we know with implied volatility is that implied volatility, like insurance contracts, have an over expectation, over expectation. of the actual move in the stock.
Meaning that if implied volatility, sorry for jiggling the camera there, if implied volatility's reading is 20% right now, which is what it is in this instance, right? This is a 20% IV range. If implied volatility's reading right now is 20%, when we actually see the math play out over time and the numbers play out, meaning the stock, okay, let's say the stock actually moves and starts trading over time. What we actually see is that the stock moves less than this number suggests long term. That means that implied volatility always bakes in an over expectation of the stock moving.
So in English what this means, as I try to explain it to you guys, is that if the stock is assumed to move $10 up or down. When we actually see the stock play out its movement, it may only move $8 up or down on average, right? So the implied volatility was suggesting a 20% move, but maybe the stock only moved, let's say, 17%. Or maybe the stock only moved 15% long-term, or 10, or 8, or whatever the difference is. It doesn't matter.
But the reality is, is that long-term, A stock will never consistently move at the implied volatility reading. Okay. Does that make sense? It will never consistently move at that number. Now it could move.
more than that here and there right so it's never going to be 100 probability of success but long term the markets always overestimate and market participants always overestimate how far stock might move up or down now think about this logically right we're really bad as like human beings like we are really really bad at predicting how far the market might go up or down that's just a natural thing Anytime that we have to predict into the future and try to plan out the future movement of a stock, we're either going to overshoot on the high end or overshoot on the low end. And the reality is that the stock always moves somewhere in between this range. Okay?
Does that make sense? So let me get some thumbs up or something on the live stream if you guys are joining us because I want to make sure we get this concept down. Okay? So let me just kind of draw out another example here because I want to make sure that we do this. And we'll just use some kind of real numbers.
All right. So I see some thumbs up coming in. So if implied volatility, right, so if implied volatility is expecting a 20% movement in the stock, when we actually go back in time and look at historical volatility, meaning how far did that stock actually move, we might find that the stock actually only moved on average 18% of the time, okay?
So implied volatility was suggesting a 20% move, but actually only 18% of the time. Or maybe the stock was suggesting a 40% move, but then we go back and we actually look at it, and it's only a 36% move, right? Now, the numbers can still be big. It doesn't matter.
36% is still a huge move, right? But the reality is that it's always less long-term than market participants, me and you, everyone else who buys options, if you do at the money. I don't, but a lot of people do. If you buy options at the money and you basically determine these numbers through your actions, you are always going to overestimate how far the stock might move.
Now, if you think about this concept, just like insurance, that means that if this option contract we talked about up here was worth $3 at the beginning, then that $3 has some sort of baked in over premium or additional premium because implied volatility is never going to be as high or actual movement is never going to be as the markets expect. Just like with insurance, the insurance company is going to charge me more money So that it covers the fact that I'm going to die 1% of the time, but they're going to charge me like I die 3% of the time. So the reality is that if you're an option buyer, just like I was an insurance buyer in that example that we had for insurance companies, right? I bought life insurance, whatever the case is.
If you're an option buyer, you are paying more money for those contracts than they're actually worth because implied volatility is actually lower. long-term than what is baked into the initial pricing. Okay.
Does that make sense? You guys following this, if you guys are on the live stream, just want to know what you guys are thinking here. So I make sure we get all of these concepts together.
Okay. So for this reason, the reality is here, folks, is that in many, many, many cases, right? Option sellers. So people who act like insurance companies, option sellers have a baked in edge based on implied volatility.
They have a baked in edge based on implied volatility. And what this means is that if they are consistently selling option contracts, consistently selling option contracts, over time, not overnight, it's not an overnight thing, over time they capture whatever implied volatility difference there may be. Now when we went back and historically tracked like DIA, which is the Dow Jones Industrial Average, we've got a video on this on the website.
I'll link it up here in the description. I guess in the post here once we're done with the live stream. But when we went back and historically tracked the DIA and we tracked implied volatility, so what people thought that the Dow Jones would do every single month versus what it actually did, historical volatility, what we found is that this difference was about, let me just move the paper up here so you can see it, 6.25%.
There's a 6.25% difference. That means that if the market participants expected the Dow to move roughly 12%, it only ended up moving 6%. Do you guys see that? That difference? That's a huge edge that we have.
That's our edge. It's this over expectation. And remember, the options were priced assuming a 12% move.
So if you were an option buyer, you paid money assuming the Dow was going to move 12% and it only, only moved 6%. Okay? Does that make sense? You guys getting this?
If you guys are getting this, let me know in the comments real quick because I just want to make sure we're doing all good stuff. Can you guys see the screen okay too? I just want to make sure I'm doing all these things.
Okay, good. So we're getting some likes in here, which is good. All right.
So now what do we have to do? Now we have to determine IV rank, right? Okay. Now this is, I guess, an easier concept. This is the hardest concept to grasp is this implied volatility edge.
But hopefully that was a good explanation of it and kind of using the insurance company thing, I think. was helpful because this implied volatility edge is so critical to your understanding of options trading success. It's just this whole idea that long, long, long term, the market always overshoots what the stock might do. It always over expects. So now we know that we generally want to sell options.
And this is a concept that I've tried to get across to a lot of people recently here. And I think hopefully it'll be helpful to you guys. But long term, and let me just say this long term.
it always pays to sell options. Okay. I want you guys to know that for sure, because that's the key foundational element.
It will always pay to sell options long-term. Now, look, we still want to be smart about how we do this. So what I say is this, when implied volatility is high or IV rank is high, which we'll talk about here in a second. Okay. When implied volatility is high, this over-expectation in pricing might also be higher.
Okay. So the markets might overshoot implied volatility by a bigger margin. Let's say they over expect the stock to move by 10 percent.
OK, so there's their markets overshooting by 10 percent. When implied volatility is low, the markets might overshoot by let's say 5%. So they might over expect by 5% or 6%, whatever the case is.
Remember with DIA, the long-term average was 6.25. In some cases, it was 13. In some cases, it was 3. The average was about 6.25. When implied volatility is high and we know that our edge is at its greatest point, I'm running out of Sharpie, I guess. We know that our edge is at its greatest point. Then we want to scale into that type of position with more money.
Okay? So this is where we start talking about position sizes of 3% to 5%. You can't be shy in these situations. You have to scale into your position, meaning trade more contracts, different varieties of contracts like SPY, DIA.
You trade everything out there. you want to just generally allocate more money because your edge is much higher, right? You get paid more money for contracts that are going to be worth a lot less. When implied volatility is low, and this is the key, I don't think many people get this concept, and maybe I haven't done a good job explaining it over the last couple months here, but when implied volatility is low, we still have an edge. Now, it's not as great as when implied volatility is high, so we still have an edge, maybe 2%, 3%, 4%, 5%.
It's smaller. So, we can still generate a positive expected return, but now we want to scale our position size down to say 1% to 2% or 1% to 3%, okay? We want to actively still trade options, that's key, but we're going to make a little bit less money long term. And we'd rather just wait for these better opportunities to come along where we could make 3, 4, 5, 6x what we're making during low implied volatility, okay? So does that concept make sense?
I want to make sure you guys are following along here, so give me some thumbs up or... comments or something like that. I see Wendell joining in.
Dom, awesome. Thank you guys. I appreciate it. Okay.
So that's what we want to do. We still want to sell options long-term. We still have an edge, but when our edge is greatest, when it's maximized, then we want to scale in. And when our edge is lower and it's still prevalent, but it's not as great as when implied volatility is high, then we just want to scale down.
Okay. So that's what we want to do. Now the question becomes, how do we find these numbers, right?
Like how do we know if implied volatility is high or right? Like that's the question. So Is 20 high?
Is 30 high? Is 50 high? What is that difference? Okay.
So here's what we want to do. We want to start looking at what's called IV rank or percentile. Look, it doesn't matter. I know I'm going to get a lot of people, or I'll say, or percentile.
Okay. And I'll get a lot of people who will say, well, you should use IV rank versus percentile or percentile versus IV rank. And look, ultimately it doesn't matter.
They generally get to the same area, right? But if you're using the concept, the concept is the most important thing because what you're doing is you're making everything relative, meaning you're doing apples to apples comparison versus like oranges and pears and bananas, right? All kinds of different things.
So let's take two stocks, okay? So the first stock that we'll take here is let's say Apple, ticker symbol AAPL, and then we'll take GE, okay? And I'm just going to use some numbers just to prove the point. These are not actual numbers at this time, just again, using the numbers to prove the point. Let's say that Apple stock right now has implied volatility, okay, the actual reading of let's say 20%.
We're just going to use just basically raw numbers that we used before, okay? So the actual implied volatility is 20%. Let's say GE also, ironically, because I'm making this up, has implied volatility of 20% as well. So if you looked at it just on this basis, okay, of looking at implied volatility, you'd say to yourself, well, They look to be the same, so it doesn't matter which one you trade. They both have implied volatility of 20%.
But here's where I think most people miss the mark is that Apple is a totally different company than GE. Apple's more technology, consumer, GE more, I don't know, you call it industrial, business services, you know, whatever, you know, I mean, it's their technology too, but you know, more of that, right? So 20, a 20 reading on Apple may be relatively high or maybe relatively low, right?
We don't know what that reading is. So what we have to do is we have to go back historically and we have to look at it. Now, look, there's software that can do this, just so you guys know. So you don't have to do this. I'm just talking through the process here.
But let's say that the high over the last year for Apple in implied volatility was, I don't know, somewhere around like 60, okay? And the low was somewhere around like 10, okay? Then in this case, 20 is actually kind of on the low end, right? If the low was 60, but it's seen as high as...
I'm sorry, if the low was 10, but it's seen as high as 60, then Apple's kind of around this low rank, right? Relatively speaking, like if we ranked 20 inside of 10 to 60, 10 being a relative zero base and 60 being a relative 100 top end level, 20 is kind of low. If we look at GE and let's say we historically go back and we look at all of the GE pricing for volatility and we say, okay, the highest that it's been recently is let's say 25 and the lowest that it's been is let's say three, like it's had implied volatility down to three. Well, then 20 becomes actually relatively high for GE, right? So you can't look at it.
The point here is you can't look at it on a raw implied volatility basis because you're comparing the two. Literally, apples to oranges and grapes and pears and bananas and all different companies within different industries. You have to use either a ranking or a percentile.
Now, look, I don't care which one you use. Just use one and use one, right? So we use rank.
It's much easier to calculate. Simple for our software that we have on the website so people can use it. We can use percentiles, just much harder calculation for thousands of people who buy our software and we're, you know, kind of calculating lots of data.
Generally, they're going to track about the same, okay? But what it does is it compares apples to apples. So now let's say that we actually use ranking and I'm not going to do the rank calculation here, but let's say just like Apple's rank right now is let's say the 15th rank and GE's rank is actually, let's say the 80th rank. And I just made those up. I'm not calculating, but we can basically say, okay, if Apple's ranking in the 15th on a scale of one to a hundred and GE's ranking in the 80th rank scale of one to a hundred, 100 being really high implied volatility, great option selling opportunity.
Okay. and Apple at 15 being, okay, not that high at all, pretty low, but still an option selling opportunity, we would prefer to trade GE first. Okay.
Now look, this doesn't mean we can't trade Apple. We can definitely trade Apple, but maybe our Apple position is 1% and maybe our GE position is let's say 4%. Okay. So do you guys see how we're scaling into this?
We're not just arbitrarily saying, okay, we'll just trade whatever the heck we want to trade. No, we're looking at this and on a relative basis, which one is relatively higher than the other one, right? Which of all the stocks that we're looking at, we don't just do this with GE and Apple, we just do this with everything, right? Like what securities are on our watch list that have really, really high implied volatility, relatively speaking, rank or percentile, that give us the best opportunity to trade options on, okay? And that's how we end up using IVRank.
All right, so I think that pretty much covers what we're going to talk about here with implied volatility. Hopefully, that little discussion was helpful. If you guys have any questions, those of you who are on the live stream, I appreciate you guys participating and joining in. Please let me know.
I did have some questions that people had submitted before then. I don't know if they were able to get here or not, but some of the questions I think that people had, or at least one question I wanted to talk about in particular, but somebody said implied volatility percent, I'm sorry, implied volatility rank doesn't account for, or does sometimes account for random spikes inside of implied volatility. I think, I don't know, Sam, is that your question?
I think it accounts for implied volatility or spikes that might happen. So if we get a random spike in implied volatility for Apple up to say 80, then it might include 80, even though it was for a blip of a second. And that's where implied volatility percentile would kind of smooth out that data. Now, the reality is that yes, if you use raw ranking metrics, it will give you sometimes skewed data. What we do is we go back through and we look historically at our data when we kind of scrub it every couple of months to see if there's any of these skews that happen.
So like a really abnormal anomaly outlier and we scrub that data. And so we just remove it and go and basically take out that one data point. And so the reality is that it doesn't really affect the whole strategy. So that's what we end up doing is we end up kind of scrubbing out that data so that it's out of there. Okay, does that help out?
I think so. Let me just go through here. I want to make sure we get questions.
I see a question come in. I'm just trying to get to it. The other day on your watch list, Apple showed a rank of nine.
Then I looked at TOS and it showed IV35. I get confused which one to use. Okay, so this is a good question. So the reality is though, and I think I emailed you back on this, is that It also depends on which option contracts you use and how you calculate it.
Now TOS, what they do is there's this black box. They don't tell you how they calculate implied volatility. What we do at Option Alpha is we use a combination of weighted at the money and slightly out of the money strikes to determine implied volatility. What we also do is we weight it for an average 30 days because we're usually looking at 30-day metrics. So we're going to do this.
And so I don't know what TOS does, but I don't think that they weight it. And so what we do is we weight it for some front month contracts versus some back month. We're never just looking at one contract in particular. So we might give more weighting to the front month contracts that have, you know, maybe 29 days versus the back month contracts that have 48 days.
Right. So that's. So you might get some differences there, but generally they track pretty much the same. I mean, there might be days where it's a little bit different, like maybe what you saw.
But when we go back and historically, you know, check this, we definitely see they track pretty much the same. Does that help out? All right.
So let me know if you guys have questions. All right. Good deal. Good deal.
Good deal. All right, guys. Well, listen, I'm going to kind of end this up here. I'll definitely jump in the comments if you guys have questions later on.
Thank you guys for those of you who are, were here with me the whole time. I really appreciate it. As always, we definitely have lots of free training on this. So I'll just write this out here.
But thank you for joining me today on this. I really appreciate it. And if you could, definitely give me the little, I think it's over in the right-hand corners, like the little thumbs up or the heart or whatever the case is. But if you guys like these, we're going to be trying to do some more of these longer-term versions here and do more of these in-depth concepts with these whiteboard videos and stuff like that.
I like doing them and hopefully you guys like doing them. I'd love to know your thoughts on these. Nam said, can we trade based on expected only? Yeah, of course. I mean, like most of the trading that we do is based on the expected move.
That's how we kind of set up our strategies around that expected move. And then we know that we'll win basically a higher amount than the initial probabilities suggest. Yep. Brandon said, can we trade based on expected range only? Yep, you got it.
That's basically what we do. Yeah, we look at that expected range and then we basically, you know, trade based on that. expected range.
When I said, thank you, keep up the good work. Thanks for being here. Appreciate it. See lots of hearts and thumbs up coming through.
Thank you guys so much. Again, we're going to be jumping back on. I'll probably actually jump back on tonight and just do a little Q and A FaceTime with you guys. So if you guys have questions, let me know. Remember this is first come first serve when we started doing these Facebook lives.
So we're already starting to build a nice big piggy bank of questions that people have asked and we'll try to keep getting these answered every single day. But if you have your question, just submit it, add a comment here, share it. Let me know.
or shoot me a message. Definitely want to help out. Okay.
All right. Listen, everyone, have a great day. Thank you guys so much for being here and we'll talk to you guys soon.