Nick Katiforis

Taking the Temperature of the Market

One of the features of options involves the ability to be able to gauge the sentiment of a market in an instant. How? By using implied volatility as a measure.

Implied volatility is a best guess of how volatile traders think a market will be in the future. It is based on the current price of an option as determined by the market.

If option traders are prepared to pay more for an option they are implying that the future volatility of the market will be higher and therefore extreme price movements are possible.

If on the other hand they are generally only prepared to pay less for an option they are collectively as a group implying that they don’t expect high volatility (and therefore big price moves) in the future for that market.

Sentiment generally reverts back to a ’normal’ level over time.

The ideal time to buy options therefore is when implied volatility is low (options are cheaper) and write (sell) options when implied volatility is high. This can help to give you a statistical edge.

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