IV Rank - When Does it Matter?

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Implied volatility once you understand it is fairly simple. It’s data that you can use a multitude of ways and as usual there is a generic way to use it that everyone talks about. 

In this post I am going to show you how we use it in our framework with The LongVol Report and then actually show you it applied to a real case study where we had skin in the game. 

Most of the time we never really care about it and keep simple rules to using it which I’ll explain.

Stocks and Implied Volatility

All stocks in the market have unique personalities in terms of implied volatility (their option prices). For example, one stock might have an implied volatility of 50%, while another has an implied volatility of 100% like AI has right now. 

So, how do we determine whether a stock’s option prices (IV) are relatively high or low?

The solution is to compare each stock’s IV against its historical IV levels. 

Implied Volatility Rank (IV Rank) Explained

Implied volatility rank (IV rank) compares a stock’s current IV to its IV range over a certain time period (typically one year).

Here’s the formula for one-year IV rank:

For example, the IV rank for a 20% IV stock with a one-year IV range between 15% and 35% would be:

An IV rank of 25% means that the difference between the current IV and the low IV is only 25% of the entire IV range over the past year, which means the current IV is closer to the low end of historical volatility. 

Furthermore, an IV rank of 0% indicates that the current IV is the very bottom of the one-year range, and an IV rank of 100% indicates that the current IV is at the top of the one-year range.

Implied Volatility Percentile (IV Percentile) Explained

Implied volatility percentile (IV percentile) tells you the percentage of days in the past that a stock’s IV was lower than its current IV.

Here’s the formula for calculating a one-year IV percentile:

As an example, let’s say a stock’s current IV is 35%, and in 180 of the past 252 days, the stock’s IV has been below 35%. In this case, the stock’s 35% implied volatility represents an IV percentile equal to:

An IV percentile of 71.42% tells us that the stock’s IV has been below 35% approximately 71% of the time over the past year.

Why Does This Matter When Putting a Trade On?

So none of this matters without application and like most things in finance you can take this data and use it how you see fit. Typically the idea here has always been this:

1. High IV you sell premium not buy it 

2. Low IV you buy premium not sell it

And both are right but then we take our framework here and use it differently. Typically, we’re not looking at high IV and sell calls or call spreads against that idea. Why? Because we’re not really options traders here, we use options as a way to express an idea. So if IV is high on a name we’re analyzing we typically avoid it until it drops. 

If you’re an options trader a real easy fix is this: avoid buying directional calls/puts when IV is high. Even when the stock moves those options are not going too. 

What do we use low IV for? Again, we don’t exclusively look at low IV and just buy calls for that reason. If we analyze a stock/situation and the IV is low then it helps to consider options as a way to express the long idea. 

Carvana Case Study with IV

So, at this point you might have read about one of the big short-ideas we had in February 2022 on Carvana. 

Analysis Has Multiple Steps

Recall that if you read our research in The LongVol Report then or watched some of the content on the YouTube channel that we were short this near $150. We had analysis, like any idea in the report, as to why the stock should trade lower. 

But then comes structuring of that analysis to capture the full potential of an idea. What is the short borrow interest? What is the optionality? Then what is the implied volatility saying? 

Today, at the time of this article IV is at +141%.

Back in Feb-May of 2022 the implied volatility was much lower. 

When IV rises like it is today it translates into an increase in the underlying cost of the options, like on Carvana today. What that means is one is better off selling premium, at this point, than buying it. In this example, the directional put trade is all but over because IV is too high. 

But does that mean just because IV is high that the move is to go an sell premium? In some traders eyes, yes. In ours, no. 

Why? Because we’re not exclusively “options traders” we’re portfolio managers and we look at ideas from a framework we use and just apply options as a way to express the idea in certain situations. 

Now, let’s look at historical implied volatility and implied volatility.

As we can see, it was relatively low for a few years but then began to rise dramatically as issues persisted with the company.

With out framework the analysis of the company came first. Then the analysis of how to we actually make serious money from that which led to looking at IV etc. to then determine: 

  • What duration options to use
  • What strikes 

So implied volatility in this case helped us to filter out the final part of the analysis so we can put the trade on.

Final Word

So, the bottom line is that IV is just a piece of data that anyone can take and apply as they see fit to an array of strategies. 

What strategies you deem to be best is obviously subjective. 

For us at The LongVol Report we apply it at the end of our analysis when we are trading value stocks, big-shorts and swing-trades. When we use the Momentum Monitor we don’t really need to consider IV as much because the names within there usually stay within a range unless earnings season arrives. 

For you directional traders simply looking at the IV on any idea you have takes less than 1 minute to do and it can be the difference between efficient capital allocation and simply just gambling on an idea. 

Thanks for reading.


IV Rank vs IV Percentile FAQs

IV rank and IV percentile are not the same. Both IV rank and IV percentile examine current levels of implied volatility, but they do so using different metrics. IV rank compares present IV to both high and low volatility levels over the past 252 days; IV percentile tells us the percentage of days over the last year when IV was lower than its present level.

IV rank tells us whether the current implied volatility is high or low in relation to the historic one year volatility of an underlying. 

When the IV percentile for an underlying is high, that implies option premiums will also be elevated. This may be a good time to sell premium using options strategies such as strangles, straddles, vertical spreads (credit spreads) and iron condors. However, if you believe the stock price will experience even higher volatility in the short-term, debit spreads may be more appropriate. 

Additionally, with low IV percentile, traders tend to favor net long positions in options. 


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About the Author

Daniel Bustamante is the founder, managing partner, and CIO of Bustamante Capital L.L.C., a multi-strategy hedge fund management firm based in San Juan, Puerto Rico. He has over 10 years of experience in the financial industry, specializing in equities, futures, and event-driven trading strategies.

He is also the founder of TheLongVol.com, a blog and newsletter that shares his insights on his investing process, travel, and other private investments. He has been featured in Bloomberg, Arizona Business Journal, Business Insider, Yahoo! Finance, Forbes, Seeking Alpha, and other publications over his career on Wall Street.


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