Understanding Options Part 2 - Implied Volatility and the Dreaded IV Crush

Back with part 2! Yesterday's post gained quite a lot traction and spurred me to write this part faster. Today I'll be going through Implied Volatility or IV for short.

Ok remember Vega? Vega is the risk of changes in IV. And in very layman terms, higher IV = more expensive contracts and likewise, lower IV = cheaper contracts. IV essentially measures the option's pricing sensitivity to changes in VOLATILITY. In general, IV affects OTM options more, as OTM options has less Delta in its pricing calculations. Remember how we talked about big events such as earnings yesterday?

So what does that mean?

Ok so remember yesterday's scenario of how in general when price goes up, a call options contract would gain value? In general yes, BUT that depends on when you bought the contract

You are exactly right. This is especially when you buy an options contract when IV is extremely high, and past the big move that you were anticipating, IV dips to low levels, causing an event known as IV crush.

Personal example:

Did you expect a greater loss than 270 USD/contract? Well, if you did, you're wrong. Although price plummeted, it didn't reach my strike price, and when market opened? Each contract was worth only 9 USD when market opened. There was a huge drop in volatility, as earnings was over, and the huge drop in IV is known as IV crush, resulting in the value of options (especially OTM ones), losing a ton of value, resulting in me earning about 121 USD per contract.

How do you make sense of this? Personally I feel like any IV that is <20% percentile, means that options are extremely cheap and good value. Anywhere between 20 to 50% is alright, and anything above 50% would be expensive. On the right, you can also compare the IV with 1 year's worth of data, to roughly see where IV is at (I usually compare it with Average and Low to look for value).

One of my favourite ways to generate income, is by selling CASH-SECURED PUT OPTIONS. Slight refresher, put options = sell direction. If I sell a put option = I am willing to buy shares at that price. So taking GME as an example, if I am comfortable with BUYING the shares at lets say 20 USD, I would then have to have 2k USD (20 USD x 100, remember how we have to x100 for options?), to sell a 20 strike PUT contract. So I allow for my idle cash to generate income for me.

When IV is high, selling put options will generate more premium, so what you can do is perhaps even sell FURTHER OTM put options (my personal strategy), so perhaps instead of selling a 20 strike PUT contract, assuming that IV for GME is very high, I could perhaps sell a 15 strike PUT contract, to generate almost the same amount of premium that a 20 strike put contract would generate when IV is low.

I love selling cash-secured put contracts, especially on stocks I love, where I'm relatively familiar with the price movement, and how fast/hard the price could move. In the instance where price dips, I'm okay with holding that stock, all while generating premium. Huh, but Ivan, what if I get assigned already, I cannot sell cash-secured puts anymore , don't worry, first off, you will own the stock for lesser than what market was initially (think of it as a discount), then minus the premiums you generated, do you see how in the end, you forked out less cash? And yes assuming that's all your capital and you cannot sell cash-secured puts anymore, you can sell what we call a covered call!

I'll be going through what a covered call is in the next sharing, and sharing my favourite options strategy - the Wheel Strategy. Psssst, if you would like a head start, you can go and do some homework to search what a covered call is.

Hope you gained a wrinkle or two and show more insights to how I approach selling options to generate income!