Let’s get this out in the open right away. Implied volatility is very important for an option trader. Let me repeat that. IV levels are important. However, many option traders will place the importance of IV levels above that of the expected move or non-move of the underlying. To me, this is a big mistake.

Changing Your Thought Process

I have so many students who get caught up in this thought process. When IV is elevated, they think the only option position to consider is selling premium. Of course, when IV levels are lower, it’s time to buy options. Now don’t get me wrong, I am not saying to go out of your way to sell cheap premium and buy expensive premium. But what matters more? For example, if I am selling a call credit spread, is it more important that the underlying stays below the short call strike or that IV is elevated? Clearly, it is more important for the position to profit than to sell expensive premium.

Best-Case Scenario

The best-case scenario to is to have expensive premium and for the underlying to stay below the short strike or at least for the position to profit. In these situations, I like to say a trader has more ducks in a row. I cannot tell you how many times I have heard about option traders selling put credit spreads when the market and stock moved lower and IV levels increased and then getting run over when the stock kept moving lower despite elevated option premiums having been sold.

What Is More Important?

IV levels are important and an understanding of them can be very beneficial to an option trader. But as I said earlier, isn’t what the underlying does even more important? Think about that next time you look at consider a potential trade.

John Kmiecik, Market Taker Mentoring