The "normal" implied volatility (IV) range is subjective and depends on the specific asset and market conditions. However, a common comfort zone for many traders lies between 20% and 25%.
Understanding Implied Volatility (IV)
Implied volatility (IV) is a key concept in options trading. It represents the market's expectation of how much the price of an underlying asset will fluctuate in the future. It is "implied" because it's derived from options prices, not directly observed.
Factors Affecting IV
Several factors can influence IV, including:
- Market Sentiment: Bullish or bearish sentiment can significantly impact IV levels.
- Economic Events: Major economic announcements or events (like interest rate decisions or earnings releases) can lead to increased IV.
- Time to Expiration: Options with shorter times to expiration typically have lower IV than those with longer times.
- Supply and Demand: High demand for options usually leads to higher IV.
Interpreting IV Ranges
While 20% to 25% is a frequently cited range where many traders feel comfortable, this isn't a hard-and-fast rule. The "normal" range can vary considerably across different assets and time periods. For example:
- Low IV: An IV below 20% might indicate a period of relative market calm or low expected price movement.
- High IV: An IV above 25% might suggest heightened uncertainty or anticipation of significant price swings.
Practical Implications for Traders
Understanding IV ranges helps traders in several ways:
- Options Pricing: IV is a crucial input in options pricing models.
- Trading Strategy: High IV environments are often suitable for options selling strategies, while low IV environments might favor options buying.
- Risk Management: Monitoring IV helps assess the potential risk associated with options positions.
Example
Imagine you're trading options on a tech stock. If the IV is consistently around 15%, you might consider it relatively low. However, if it jumps to 35% after an earnings announcement, you'd recognize that the market expects a significant price move.
