Understanding the volatility factor while trading options is vital in becoming a successful options investor. Option prices will increase or decrease depending on what the implied volatility (IV) does and regardless of whether the stock price goes up or down. When the IV is high it’s dangerous to buy an option. Try to buy an option while the IV is low.
Think of a river that you normally drive by. Most of the time that river is about the same size right? However there are times when heavy rain occurs and that river is at flood stages, much higher than normal. But you know that eventually it will return to its normal size. There are other times when the river is at drought stages, running very low. At this stage you know that it will eventually return to its normal size as well.
Volatility is the same. When its high (flood stages) you know it will drop sometime soon. When it’s low, you know it will increase soon. If you bought into an option trade when the IV is high you know that it will soon go down and when it does you will start losing value in your options. If you bought an option while the volatility was low, it will soon go up and when it does you will start gaining value in your options. This will happen whether or not you have calls or puts.
When the IV is low buy options “out of the money.” When the IV is high buy options “in the money.”
By: Josh Willis
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