How to Read IV Rank After Market Volatility

Key Concepts

• IVR (Implied Volatility Rank): A metric that measures current implied volatility relative to its historical range over a specific period (e.g., one year).
• Volatility Expansion/Contraction: Periods where market volatility increases or decreases.
• Skewed IVR: A distortion in IVR readings caused by outlier events (e.g., major market crashes, geopolitical events) that dramatically increase the historical volatility range.
• Short Premium Trading: A trading strategy that involves selling options to collect premium, profiting from time decay and/or volatility contraction.
• VIX (Volatility Index): A real-time market index representing the market's expectation of 30-day forward-looking volatility.
• SPY (S&P 500 ETF): An exchange-traded fund that tracks the S&P 500 stock market index.
• GLD (Gold ETF): An exchange-traded fund that tracks the price of gold.
• Outlier Events: Significant, infrequent market events that cause extreme price or volatility movements (e.g., COVID-19 pandemic, tariff tantrums).
• Iron Condor, Strangles, Puts: Specific options trading strategies often used in short premium trading.

Understanding and Adjusting for Skewed IVR

The core problem addressed is how large volatility expansions can skew IVR, causing it to underestimate implied volatility inflation relative to historical averages. This skew results in lower IVR readings for extended periods following a major spike. The objective is to adjust the interpretation of IVR to account for this overstatement caused by outlier events like the COVID-19 pandemic or "tariff tantrums."

IVR is a metric that looks at the average implied volatility within its annual range. When an underlying asset experiences a wide deviation from its average volatility due to a significant event, it skews the results, making subsequent IVR readings appear lower than they might otherwise be.

Probability of Short-Term VIX Contraction at Different SPY IVR Levels

Short premium traders fundamentally rely on short-term volatility contraction. The research analyzed the probabilities of VIX contractions at different SPY IVR levels, using data from 2015 to the present.

Methodology:

• SPY IVR was bucketed into ranges: 10-20, 20-30, and greater than 30.
• The study observed the probability of the VIX contracting by at least 5% and 10% within a 45-day window for each IVR bucket.

Key Findings:

• IVR Greater Than 30: When SPY IVR is greater than 30, there is a high probability (approximately 66-68%) that the VIX will contract by at least 5% in the subsequent 45 days. Even for a larger 10% contraction in volatility, the probability remains very high in this range.
• Lower IVR (10-20): When IVR is low (10-20 range), the likelihood of volatility contracting further is significantly lower, which is expected as volatility is already low.
• Middle IVR (20-30): This range is considered a "good spot" or "not a bad entry" for short premium trades, representing a relative higher end of the range with more occurrences than the 30+ range.

Argument: An IVR of 30 is considered the higher end of the typical range because it accounts for the usual year-to-year spikes in volatility. This range (IVR > 30) is identified as the "spot to start wheeling and dealing" or the "go zone" for active trading strategies.

IVR Calculation and the Impact of Volatility Spikes

The calculation of IVR depends on the annual implied volatility range for the underlying asset. Volatility spikes dramatically increase this annual range, which in turn skews the high end of the IV reading.

Consequence of Skew:

• After a major volatility spike, IVRs for the subsequent period tend to be compressed, leading to lower readings.
• It becomes challenging to find high IVR readings (e.g., "finding the 50 IVR after COVID is hard") because the outlier event significantly expanded the historical range.
• While these outlier events must be accounted for in the historical data, they "skew it," making an IVR of 30 or 40 "more significant." The speaker suggests that a 30 or 40 IVR after a major spike might effectively represent an 80 or 90 IVR if the spike were hypothetically removed (though it shouldn't be removed as it's crucial data).

Real-World Application/Market Observation: The discussion briefly diverged to current market conditions, highlighting extreme volatility:

• Gold was observed to be up $96 (2% move), then sold off $40, becoming almost unchanged after being up $300 earlier.
• Silver was up $3.90, then sold off $10.
• S&P was down 53-65 points, NASDAQ down 400 points, and crypto (Bitcoin) was down $3,000.
• GLD (Gold ETF) volatility was "up huge," with an IV rank of 117, noted as "about as high as it's ever been." This illustrates a live example of an extreme volatility event. Later, as gold went lower, its volatility (GLD IV rank 114) was observed to be coming in, which is an expected dynamic.

Detailed Probability Analysis of VIX Contraction (5% and 10%)

Further analysis confirmed the probabilities of VIX contraction across the defined IVR ranges (10-20, 20-30, 30+).

Probability of at least 5% VIX Contraction in 45 Days:

• IVR 10-20: Much less likely for volatility to contract.
• IVR 20-30: A "good spot" or "go zone" for trading, representing the relative higher end of the range. There are more occurrences in this range than in the 30+ range.
• IVR 30+: A "really high probability" (above 50-60%) of VIX contraction. This is considered the primary "go zone" for short premium strategies.

Probability of at least 10% VIX Contraction in 45 Days:

• Similar to the 5% contraction, a 10% VIX contraction is also very likely when implied volatility is "super high."

Perspective on IVR Ranges:

• IV ranks of 80 or 90 are very rare.
• IV ranks of 30 or 40 represent the high end of the practical trading range.
• The 20-30 range is a "go zone" where traders can be active.
• The 10-20 range is when traders should "pump the brakes" or be more cautious.

Conclusion and Actionable Insights

Main Takeaway: Significant implied volatility contraction is highly likely when IVR is greater than 30, regardless of historical context.

Actionable Insight for Traders:

• An IV rank of 30 is generally a good threshold to start considering short premium positions, such as iron condors, strangles, or selling puts.
• Adjustment for Outlier Events: If a large volatility event (like COVID-19) has occurred within the last year, causing a significant skew to the volatility range, this threshold can be lowered. In such scenarios, the 20-30 IVR range can be considered the "higher end of the range," making "20 plus" a good entry point for short premium trades.

Current Market Context Example: At the time of the recording, SPY IV rank was 22. This was noted as being in the "go zone" after having been below this level for several months, indicating a recent spike in volatility that makes it an opportune time for short premium strategies, especially considering the adjusted threshold due to potential historical skew.