Monday, February 25th 2019
Surf the IV Implied Volatility Surface
Summarizing the implied volatility surface is an important step to understand the options trading environment for a symbol. Begin by understanding the parameters.
Summarizing the implied volatility surface is important to understand the options trading environment for a symbol. The three most important parameters are short-term IV, long-term IV, and strike slope. Short-term lower than long-term is usually bullish for the stock price. A steepening slope has an ambivalent relationship to the stock price. Other important parameters include derivative and implied earnings effect.
Surfing the BVI (British Virgin Islands) is my favorite thing to do.
Surfing the IV (Implied Volatility surface) is my second.
Summarizing the implied volatility surface is an important step to understand the options trading environment for a symbol. Here are the most important parameters in the surface:
- Short-term IV: 30 days constant maturity implied volatility.
- Long-term IV: 2 years constant maturity.
- Strike slope: the slope of the line at the tangent of the 50 delta.
Knowing these three parameters can tell you a lot about what is happening for an underlyer.
First, what is the S.T. IV vs history? Is the IV rising? This is a bearish sign usually. Second, what is the relationship between the S.T. and L.T. IV?
To understand all aspects of IV, it's important to look at the options data. Usually, the short-term is lower than the long-term and that usually is a bullish sign for the price of the stock. See our post on the term structure.
Lastly, what is the relationship of the low strikes to the high strikes and what is the trend in this reading? A steepening slope has an ambivalent relationship to the stock price; at low S.T. IV times, the slope is often high reflecting investors desire to protect recent gains in the stock (ORATS communicates the slope as positive when the low strikes are above the high strikes IV). The strike slope is important for deciding what type of strategy to employ. For example, when the slope is steep a collar is expensive (the puts IV is much higher than the calls IV) and the investor may want to consider a put spread collar (buy a higher strike put and sell a lower strike put), of course if this meets the investment objectives.
There are other important parameters of the surface, for example:
- Derivative (curvature or kurtosis) is the amount the slope changes as you move away from the 50 delta.
- Implied Earnings Effect is the amount the expirations with an earnings announcement will be affected by the expected earnings move in the stock.
A high Derivative reading usually indicates that options traders expect more movement in implied volatility.
Of course, a high implied earnings effect tell of a large expected move on the earnings announcement.
ORATS offers these IV surface parameters for the current market and historically. Feel free to contact us if you'd like to learn more about equity options data.
Options pricing models produce theoretical values for options and implied volatilities. Here we show common methods for calculating IV and how to interpret them.
Implied volatility, contango, and forward volatility can be used to predict underlying movement. Ex-earnings IV for stocks is explained. Backwardation is described as is the flat volatility method.