How To Determine If An Option Is Cheap (Underpriced) Or Expensive (Overpriced) � Part 2

Go back to Part 1.

How To Determine If IV is High or Low? (Cont�d)

Example:



Picture courtesy of: ivolatility.com

For AAPL, the IV figures (gold colored line) range between 24% to 54%.
The peaks / highs of the IV charts are around 45% - 55%. When the IV is relatively high for the stock, that means the option�s price is relatively expensive.
On the other hand, the bottoms / lows of the IV charts are about 25% - 30%. When the IV is relatively low for the stock, that means the option�s price is relatively cheap.
The area between 35% - 40% seems like the average area. Hence, when IV is around this area, the option�s price can be considered quite �reasonable�, not �expensive� or �cheap�.
Notice that when the IV is at the peak or at the bottom, it tends to move back towards its average area.

Implied Volatility (IV) & Options Strategy Consideration
When IV is relatively low (option is cheap) and is expected to rise, buy options (i.e. consider options strategies to take advantage of the expected move that allow us to be an option buyer).
For example:
You expect the price to go up in the near term. Currently, the IV is also relatively low and it�s expected to increase, as it is approaching earnings announcement in a few weeks ahead. When you buy Call options, the option�s price could increase not only due to the rising stock price, but also as a result of the rising IV. Even when the price stays flat, the option�s price might still increase due to the increase in IV.
Buying Straddle or Strangle also can benefit from the rising IV.

When IV is relatively high (option is expensive) and is expected to drop, sell options (i.e. consider options strategies to take advantage of the expected move that allow us to be an option seller).
For example:
When you�re bullish, you may want to consider a Bull Put Spread, which allow you to sell options (and collect premiums) with a limited risk.
On the other hand, when you�re bearish, you can consider a Bear Call Spread.

To understand more about other aspects of Implied Volatility, go to: Understanding Implied Volatility (IV).

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