Analysis of Volatility Extremes

In today's edition of IVolatility, we want to focus on stocks with extreme readings in their implied volatility relative to their ranges. From of our scans, we have created a candidate list of very high and very low implied volatility stocks. The method used here compared implied volatility to its recent implied volatility range. This comparison was then expressed within a range of 0 to 1 (0= new low, 1= new high). With this information some volatility trading strategies might be designed or some directional plays avoided.

Readings from above suggest that implied volatility is at very high levels or is currently establishing new highs. Care must be taken in buying options on these stocks. With implied volatility being as high as it is on these stocks, the probability of loss when buying options on one of these increases dramatically. This is due to the that fact that you may get the direction right (increase in your delta) but a collapse of implied volatility (vega) back to more normal levels may more than offset any directional gains that you accumulate on the trade.

Readings here suggest that implied volatility is at very low levels or is currently establishing new lows. On this side, care must be taken in selling options on these stocks. With implied volatility being as low as it is on these stocks, selling options successfully here is a very unfavorable bet. This is due to the fact that any strong directional move combined with an increase in implied volatility (vega) back to more normal levels, may not allow you to find a suitable hedge to offset your risk in a timely and cost effective manner. In options parlance, the gamma and the vega of your option may be too unmanageable.