Introducing OptionsPlay’s IV Rank and Liquidity Indicator
OptionsPlay has just launched our new IV Rank & Liquidity Indicator to the platform. Now, you’ll be able to gauge how cheap or expensive an option is and liquidity within the Quote Bar.
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What is IV Rank?
Implied Volatility Rank or IV Rank is a metric of measuring implied volatility and where it currently is with relation to the previous 1 year. This is useful as some stocks are more volatile than others, making it difficult to compare volatilities between stocks. It is calculated by taking the highest and lowest implied volatility figure the past year and comparing it to the current implied volatility. An IV Rank of 100% represents a stock at its highest implied volatility over the past year and an IV Rank of 0% indicates that the current implied volatility of the stock is at its 1 year low. As a general rule of thumb, an IV Rank above 50% is considered high, and below 10% is considered low.
For example, if a stock’s implied volatility over the past year has ranged from 30% to 60% and the current implied volatility is at 40%, then the current IV Rank would be 33%.
If in the same example, the stock’s implied volatility is at 50%, then the IV Rank would be 66%.
How can we measure an option’s liquidity?
There are over 4200 underlying symbols that have listed options in the US. However, over 85% of those symbols have an open interest of under 100 contracts across all strike prices. It is important to identify the most liquid symbols for options trading when placing a trade. OptionsPlay’s easy 1, 2 and 3 ranking provides all users with a gauge for the liquidity of any symbol for options trading.
1 – Very Liquid – Executions should occur within 1-3 cents away from the mid-point.
2 – Somewhat Liquid – Executions should occur within 5-10 cents of the mid-point.
3 – Not Liquid – Transaction costs on these symbols may be sizable, start at the mid-point but may require a 10+ cent markup before executions occur.
How should I use IV Rank and Liquidity for trading options?
The rule of thumb is to buy options that have an extremely low IV Rank (below 10%) and sell options that are high (above 50%). Options with a low IV are cheaper to purchase and work well for strategies such as long calls and puts or debit spreads. However, when IV is high, options are more expensive and selling options provide an edge as more premium is received by the option seller. The option seller can use strategies such as short calls and puts or credit spreads.
Lastly, liquidity metrics can help investors gauge where to place orders with respect to the mid-point. Liquid symbols will see orders executed close to the mid-point and have tighter better bid/ask spreads. If you are trading symbols that are not liquid, be aware of the increase in transaction costs that will be required to enter/exit a trade.
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