Using an option with a strike price near the underlying asset’s current price and an expiration closest to the date you want to find the implied volatility for will provide the best results. As you move further away from the underlying asset’s current price, options pricing is often skewed by forces other than implied volatility.
How to use implied volatility
Investors can use implied volatility in their investment decision-making process in a few different ways.
IV may provide investors with an idea of how risky a particular stock or asset is. For example, a stock with a high implied volatility has a higher chance of producing returns farther away from expectations than a stock with lower implied volatility. An investor with low risk tolerance may put a smaller allocation toward a stock like that and a bigger allocation toward low-IV stocks.
Options traders may pay close attention to implied volatility since it’s one of the main factors driving options pricing. Considering IV typically reverts to the mean, a spike in IV may be an opportunity to sell options contracts, while a drop in IV could be an opportunity to buy options. Options traders can use metrics like IV percentile or IV rank to determine whether implied volatility is currently high or low on the options contracts an investor is considering.
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