timothy sykes logo

Penny Stocks News

How to Use Implied Volatility in Options Trading

Timothy SykesAvatar
Written by Timothy Sykes
Updated 4/20/2023 8 min read

Using implied volatility in options trading is just as important as using it in stock trading. The more volatile a stock, the better its chance to make a tradable move.

The options market is geared to the kind of active trading I teach in my Trading Challenge. It should come as no surprise that implied volatility is valued even more than in the stock world.

If you have a bad impression of volatility, it’s time to unlearn it. Options trading is counterintuitive to the way so many of us were raised…

The old idea that “time in the market beats timing the market” doesn’t apply to smart options trading. If you have no idea what I’m talking about — read on to skill up!

Are you new to options trading? Read my guides on the basics of options trading and how to make money from this trading niche.

What Is Implied Volatility?

© Millionaire Media, LLC

Implied volatility (IV) is the estimate of a stock’s future volatility over a period of time. The more volatile a stock, the faster its price moves.

Some options traders base their entire strategies around IV. Volatility is a great way to generate the price swings necessary for an option’s underlying asset to hit its strike price.

How Does Implied Volatility Work?

Implied volatility works by predicting the speed of price changes. The IV of options is determined by trader consensus.

This consensus is influenced by how market participants view an asset’s past volatility, and its future potential to increase or decrease this volatility.

How Implied Volatility Affects Options

Here are some examples of how IV affects options contracts:

  • IV affects the pricing of options. High-IV options are usually in more demand, so they have higher prices. On the flip side, options with low IV usually have lower prices.
  • IV isn’t static — it can change as time passes. This can also affect the option’s value.
  • Expiration dates influence how much an option is affected by IV changes. Options that expire sooner respond less to IV changes, and vice versa for later expiration dates.
  • Strike prices also influence an option’s reaction to IV changes. Near-the-money options respond more to IV changes. In-the-money and out-of-the-money options are less sensitive.

What about binary options? IV figures into their pricing… as well as more unsavory factors. Read my guide to binary options trading to learn more about them.

How to Use Implied Volatility to Your Advantage

© Millionaire Media, LLC

Using implied volatility to your advantage is key to many options strategies. Using top-notch charting software like StocksToTrade can be a powerful tool.

StocksToTrade is my preferred trading platform — partly, but not wholly, because I helped design it! I think it has the most versatile, cleanest charts in the business…

Give StocksToTrade a try today — a 14-day trial is only $7!

Charting an option’s past volatility can help you predict future IV. Like many things in the market, IV is cyclical. Low-volatility periods are followed by high-volatility periods. Understanding this cycle helps you make informed trading decisions.

Here are three strategies you can try to take advantage of IV:

Strategy 1: Buy the Rumor, Sell the News

Post image

Get my weekly watchlist, free

Sign up to jump start your trading education!

“Buy the rumor, sell the news” is common advice in trading. Stock prices can change in advance of events like a product launch or earnings reports. Options prices can fluctuate in a corresponding way.

After the news comes out, it’s anybody’s guess. Prices can continue trending in the same direction, or reverse course.

Why We Like It

If you have access to a powerful news scanner like the one in StocksToTrade, you can sniff out rumors before they impact price too much. You might be able to trade an option on the rumored asset before the new development is priced in.

If you try out StocksToTrade’s Breaking News Chat add-on, your chances of being early to a trade multiply.

Strategy 2: Selling Strategies for High Implied Volatility

Options with high IV are usually expensive. When option premiums are expensive, the advantages of writing instead of buying them increase.

You can also consider advanced strategies like credit spreads, naked puts, and covered calls.

Why We Like It

Being an option writer gives you another way to profit off high IV. Just be careful — selling options can get very risky!

For traders who know what they’re doing, selling options can be a valuable tool in a profitable overall strategy.

Strategy 3: Buying Strategies for Low Implied Volatility

When IV is low, some traders stock up on options contracts with far-off expirations. The idea is to hold these options with the hope that their volatility increases and they become more valuable.

I’m no fan of the hold and hope mindset…

But low-IV options contracts aren’t penny stocks. Some options traders are big fans of this approach!

Buying calls and puts, long straddles, and debit spreads are some of the strategies that can be employed here.

Why We Like It

Selling options contracts — instead of executing them — is one way this basket of strategies can become profitable.

I’m a big fan of flexibility in trading… You have to adapt to the market, not the other way around.

Implied Volatility Vs Realized Volatility

timothy sykes in matera in 2022
© Millionaire Media, LLC

Implied volatility and realized volatility (or historical volatility) measure the same thing — a stock’s price action. How do the two differ?

  • Implied volatility is calculated based on supply, demand, and market expectations. It measures future volatility, which is one of the main indicators for determining an option’s execution potential.
  • Realized volatility measures past price action. Historical volatility can inform IV because of its cyclical nature.

Both volatility measures are important when trading options.

Final Thoughts

Implied volatility estimates future stock price movements. You can use it to predict whether the option will hit its strike price.

But you’re not the first one who’s made this connection. And until you can incorporate this knowledge into your trading strategy, you’ll be at a disadvantage on the trading battlefield.

Learning from experienced traders is one of the best ways to catch up with the rest of the market.

If you’re searching for a mentorship program, check out my former student Mark Croock’s Evolved Trader. He’s taken my penny stock strategies and applied them to options trading — making $3.9 million in career earnings in the process!

Here’s a sneak peek of Mark’s curriculum:

Sign up for the Evolved Trader program today and start your journey towards becoming a self-sufficient options trader!

How much has this post helped you?

Leave a reply

Author card Timothy Sykes picture

Timothy Sykes

Tim Sykes is a penny stock trader and teacher who became a self-made millionaire by the age of 22 by trading $12,415 of bar mitzvah money. After becoming disenchanted with the hedge fund world, he established the Tim Sykes Trading Challenge to teach aspiring traders how to follow his trading strategies. He’s been featured in a variety of media outlets including CNN, Larry King, Steve Harvey, Forbes, Men’s Journal, and more. He’s also an active philanthropist and environmental activist, a co-founder of Karmagawa, and has donated millions of dollars to charity. Read More

Post image

Get my weekly watchlist, free

Sign up to jump start your trading education!

* Results are not typical and will vary from person to person. Making money trading stocks takes time, dedication, and hard work. There are inherent risks involved with investing in the stock market, including the loss of your investment. Past performance in the market is not indicative of future results. Any investment is at your own risk. See Terms of Service here

The available research on day trading suggests that most active traders lose money. Fees and overtrading are major contributors to these losses.

A 2000 study called “Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors” evaluated 66,465 U.S. households that held stocks from 1991 to 1996. The households that traded most averaged an 11.4% annual return during a period where the overall market gained 17.9%. These lower returns were attributed to overconfidence.

A 2014 paper (revised 2019) titled “Learning Fast or Slow?” analyzed the complete transaction history of the Taiwan Stock Exchange between 1992 and 2006. It looked at the ongoing performance of day traders in this sample, and found that 97% of day traders can expect to lose money from trading, and more than 90% of all day trading volume can be traced to investors who predictably lose money. Additionally, it tied the behavior of gamblers and drivers who get more speeding tickets to overtrading, and cited studies showing that legalized gambling has an inverse effect on trading volume.

A 2019 research study (revised 2020) called “Day Trading for a Living?” observed 19,646 Brazilian futures contract traders who started day trading from 2013 to 2015, and recorded two years of their trading activity. The study authors found that 97% of traders with more than 300 days actively trading lost money, and only 1.1% earned more than the Brazilian minimum wage ($16 USD per day). They hypothesized that the greater returns shown in previous studies did not differentiate between frequent day traders and those who traded rarely, and that more frequent trading activity decreases the chance of profitability.

These studies show the wide variance of the available data on day trading profitability. One thing that seems clear from the research is that most day traders lose money .

Millionaire Media 66 W Flagler St. Ste. 900 Miami, FL 33130 United States (888) 878-3621 This is for information purposes only as Millionaire Media LLC nor Timothy Sykes is registered as a securities broker-dealer or an investment adviser. No information herein is intended as securities brokerage, investment, tax, accounting or legal advice, as an offer or solicitation of an offer to sell or buy, or as an endorsement, recommendation or sponsorship of any company, security or fund. Millionaire Media LLC and Timothy Sykes cannot and does not assess, verify or guarantee the adequacy, accuracy or completeness of any information, the suitability or profitability of any particular investment, or the potential value of any investment or informational source. The reader bears responsibility for his/her own investment research and decisions, should seek the advice of a qualified securities professional before making any investment, and investigate and fully understand any and all risks before investing. Millionaire Media LLC and Timothy Sykes in no way warrants the solvency, financial condition, or investment advisability of any of the securities mentioned in communications or websites. In addition, Millionaire Media LLC and Timothy Sykes accepts no liability whatsoever for any direct or consequential loss arising from any use of this information. This information is not intended to be used as the sole basis of any investment decision, nor should it be construed as advice designed to meet the investment needs of any particular investor. Past performance is not necessarily indicative of future returns.

Citations for Disclaimer

Barber, Brad M. and Odean, Terrance, Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors. Available at SSRN: “Day Trading for a Living?”

Barber, Brad M. and Lee, Yi-Tsung and Liu, Yu-Jane and Odean, Terrance and Zhang, Ke, Learning Fast or Slow? (May 28, 2019). Forthcoming: Review of Asset Pricing Studies, Available at SSRN: “https://ssrn.com/abstract=2535636”

Chague, Fernando and De-Losso, Rodrigo and Giovannetti, Bruno, Day Trading for a Living? (June 11, 2020). Available at SSRN: “https://ssrn.com/abstract=3423101”