Lecture on Implied Volatility

Introduction to Implied Volatility

• Definition: Represents market's expectation of a stock's future price movements.
• Derived from option prices, indicating expected future volatility.
• Common beginner misconception: Option prices derive implied volatility, but actually, option prices influence implied volatility through buying/selling pressure.

Examples for Understanding Implied Volatility

• Compared option prices of Pepsi and UNP: Different prices suggest different levels of expected volatility.
• Higher option prices in UNP imply more expected volatility compared to Pepsi, as seen in historical examples with 37-day expiration cycles.

Key Concepts

• Implied volatility comes from option prices, not vice versa.
• Extrinsic value in options relative to expiration time determines implied volatility.

Implied Volatility in Real-Time Trading

• Example using Tastyworks platform comparing SPY and Adobe options.
• Higher extrinsic value in Adobe options leads to higher implied volatility compared to SPY.
• Market's expectation of volatility influences option prices and implied volatility.

Factors Affecting Implied Volatility

• Correlation between historical and expected future volatility.
• Recent stock volatility affects future expected volatility, impacting option prices.
• Visualization shows S&P 500 historical volatility and VIX relationship.

Calculating Expected Price Ranges

• Implied volatility expressed as an annualized percentage.
• Represents one standard deviation price range over next year (~68% probability).
• Formula: Current stock price ± (Price * Implied Volatility)
• Examples: Calculations for Netflix and Coca-Cola's expected price range.*

Implied Volatility Metrics

• IV Rank: Current IV compared to past year's range. Formula: (Current IV - Lowest IV) / (Highest IV - Lowest IV)
• IV Percentile: Frequency-based, shows how often past IV was below current level. Formula: Days below current IV / 252

Using Implied Volatility for Trade Decisions

• IV Percentile preferred for trading decisions due to frequency basis.
• After high IV periods, IV rank may give misleading low readings, while IV percentile adjusts better.

Implied Volatility and Earnings Reports

• IV often increases before earnings due to stable option prices as expiration nears.
• Misconception: Rising IV doesn’t always mean rising option prices.
• Historical examples: Tesla's straddle prices before earnings.
• IV increase isn’t always an opportunity for profit through buying options.

Conclusion

• Understanding IV takes practice and observation in the real market.
• Encouragement to explore and compare option prices and IV in real scenarios, especially leading up to earnings reports.
• Recommended additional resources and willingness to answer questions.