## Implied Volatility-Market Direction

Trading options requires knowledge about Implied volatility-market direction. Implied volatility implies the expectations of market participants in the underlying stock/index in near future. Implied Volatility indicates the possible future volatility (without indicating the direction of the move, it indicates only possible volatility) where are statistical or historical volatility takes into consideration last one year annualized standard deviations of price movements.

The meaning and definition of Implied volatility can be stated as expected near term volatility in the stock or index. Implied volatility is calculated using options pricing formulas (For Eg: Black-Scholes Options Pricing Model) and using the Current Market Market Price of the Options. If market price is more than theoretical Options Price, it can be said that Implied Volatility is high. Similarly, if market price of option is less than theoretical price determined by using options pricing models, it implies that the Implied volatility is low.

One can observe that options prices of stocks move high when in near future some major announcement / event is expected like earnings announcement, court judgement etc., It implies high volatility is implied in the price of the options (which is higher than the theoretical price).

Market direction can be either Bullish, Neutral or Bearish. Trading strategies in options differ on market direction. For example option trading strategies used in bull markets can not be used when markets are neutral and range bound. Market direction can be assessed using many technical indicators.

Below are some option strategies that can be used depending on Implied Volatility-Market Direction. Usually, Options with high implied volatility are sold to benefit from expected future decrease in volatility which decrease option price (Even price of the underlying is unchnaged) and Options with Low implied volatility are bought with an expectation of increase in implied volatility in near future.

**Implied Volatility Low & Market Direction Bearish**

1) Buy Naked Puts

2) Bear Vertical Spreads:

a)Buy ATM Call/Sell ITM Call

b)Buy ATM Put/Sell OTM Put

3) Sell OTM (ITM) Call (Put) Butterflies

4) Buy ITM (OTM) Call (Put) Time Spreads

**Implied Volatility Low & Market Direction Neutral**

1) Backspreads

2) Buy Straddles/Strangles

3) Sell ATM Call Or Put Butterflies

4) Buy ATM Call Or Put Time Spreads

**Implied Volatility Low & Market Direction Bullish**

1) Buy Naked Calls

2) Bull Vertical Spreads

a) Buy ATM Call/Sell OTM Call

b )Buy ATM Put/Sell ITM Put

3) Sell ITM (OTM) Call (Put) Butterflies

4) Buy OTM (ITM) Call (Put) Time Spreads

**Implied Volatility Neutral & Market Direction Bearish**

Sell the Underlying Stock/Index

**Implied Volatility Neutral & Market Direction Neutral**

**Implied Volatility Neutral & Market Direction Bullish**

It is the time to buy the underlying stock/index and avoid Options.

**Implied Volatility High & Market Direction Bearish**

1) Sell Naked Calls

2) Bear Vertical Spreads:

a) Buy OTM Call/Sell ATM Call

b) Buy OTM (ITM) Call (Put) Time Spreads

3)Buy ITM (OTM) Call (Put) Butterflies

4)Sell OTM (ITM) Call (Put) Time Spreads

**Implied Volatility High & Market Direction Neutral**

1) Ratio Vertical Spreads

2) Sell Straddles/Strangles

3) Buy ATM Call Or Put Butterflies

4) Sell ATM Call Or Put Time Spreads

**Implied Volatility High & Market Direction Bullish**

1) Sell Naked Puts

2) Bull Vertical Spreads

a) Buy ITM Call/Sell ATM Call

b) Buy OTM Put/Sell ATM Put

3) Buy OTM (ITM) Call (Put) Butterflies

4) Sell ITM (OTM) Call (Put) Time Spreads

As can be seen from the above options trading strategies which are based on Implied Volatility-Market Direction, most of the action is when implied volatility is either high or low. When implied volatility is neutral it is better to trade directly in the underlying stock or index than trading in options.

Implied Volatility-Market Direction is important while taking decision in trading options. Most of the traders either ignore options implied volatility while taking trading decisions or give little importance. As volatility is biggest factor in determining the price of the options (even when there is no change in the price of the underlying stock or index), traders should take note of implied volatility-market direction into consideration while formulating their option trading strategies.