Lesson Overview

IV Expected vs. Actual Move

One of the ways we gain an "edge" in the market selling options is because IV tends to overstate the actual expected move of a stock in nearly all cases.

Now we are believers that markets are efficient, in the sense that there is not price edge you can gain picking stocks directionally. But when it comes to option pricing we can prove that selling rich IV has been one of the rare historically and profitable “edges” to trade.

The VIX is used to forecast the 30 day future volatility of the S&P 500. In the video above we’ll track the VIX against a chart of the actual realized volatility 30 days from the time of measurement of the VIX.

On average, the VIX expected the market to have a slightly more volatile environment than has been realized over the last 8 years. The average difference between the VIX and actual volatility in this period was about 3.25%.

So for example, if stock ABC has an expected move of 10% up or down based on current implied volatility then long term the average might actually end up being 8% up or down. IV in this case overstated the move by 2%.

More Discussion

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  • Oleksiy

    Hi Kirk ! In this video you are saying that option buying is inferior to option selling. Why then at Strategy Guide we can see a lot of debit spreads ?

    • Because you can still use option buying strategies when IV is low and for directional hedging. Notice in the guide that I only put net buying strategies, never single long options. Long-term though all option buying should be less profitable than option selling which is why we do much more option selling.

  • Yes correct actual volatility is the same as historical volatility. VIX is current market expected or implied volatility – an easy way to think about it is that if the VIX is calculating a 20% move in the market for the year, when the year actually plays out it might only move 17%.

  • No not necessarily – current IV is calculated mostly using ATM or close to ATM strikes not far out strikes with wide spreads. IV can be on a shorter time period if you setup the indicator do to so

  • Chase Willis

    Hey Kirk, I like your advice and I can see your advice is much better than the most crap out there. If I may ask, Have you traded through a recession yet? Were you trading back in 2008?

    Thanks!

    • Yep we traded through 2008 and did well – it was actually the fast rebound in early 2009 that was the struggle.

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