One of the primary drivers of an option’s value is implied volatility, or IV.
Just as with a stock, the goal might be to buy low and sell high, as it’s usually with options. But that’s not always the case. Buying an option when IV levels are extremely high may not be the best bet. In this case, however, you may want to buy options when IV levels are low and sell when IV levels are high.
When you purchase an option that has an elevated premium because high levels of implied volatility, you run the risk of watching the option value go up in smoke very quickly.
Keep in mind that volatility may have a tendency to revert to the mean. High levels of IV today can decline in time to average levels. If you buy an option today worth $4 and the IV drops by several points in the coming days, that option can lose considerable value all other inputs remaining equal.
If you are buying options, a significant drop in IV may not be the only hurdle to a profitable trade. Remember that the clock is working against you as well, and that adverse market movement can also have a negative effect on your position. If you buy an option that is overinflated due to extreme levels of IV, you may simply be stacking the chips against you even further.
Can an option trading at extreme IV levels appreciate in value through market movement or a further increase in IV? Absolutely. However, trading is a game of odds, and you should always look to tilt the odds in your favor as much as possible.
While it might be necessary to buy options trading at high levels of IV, buying options that are near the lower end of their IV ranges can potentially offer better odds of a successful trade.
