Implied volatility beyond the basics: IV rank, percentile, term structure and skew
Calculate IV rank and IV percentile, read the volatility term structure and skew, and use them to decide between premium-buying and premium-selling strategies.
What you will learn
- How to calculate IV rank and IV percentile and why they can disagree.
- How to read the term structure (IV by expiry) and the skew (IV by strike).
- How to translate IV into an expected move for any number of days.
- A simple strategy-selection rule by volatility regime.
Explanation
What implied volatility (IV) is was covered in the course Derivatives: Futures, Options, CFDs and Certificates. Here we ask: is today's IV high or low for this underlying, and what does the shape of IV across expiries and strikes tell us?
IV rank and IV percentile
IV rank (IVR) places today's IV inside the 52-week range:
IVR = (IV today - 52-week low) / (52-week high - 52-week low) x 100
IV percentile (IVP) is the share of days in the last year with IV below today's level:
IVP = days with IV below today / total days x 100
They often disagree: one short panic spike pushes the 52-week high far up, so IVR stays low for months even when today's IV is above most days of the year; IVP is not fooled by a single spike. A common convention treats readings above about 50 on both as "elevated" and below about 30 as "cheap"; these are conventions, not evidence of future returns. The IV used is normally a 30-day at-the-money figure (IV30).
Term structure
The term structure is IV plotted by expiry. In calm markets it slopes upward (contango). Before earnings or during a sell-off, near-term IV rises above longer-term IV (backwardation). The shape matters for calendars (lesson 5) and earnings trades (lesson 6).
Skew
Skew is IV plotted by strike within one expiry. In index and most stock options, out-of-the-money puts carry higher IV than out-of-the-money calls because investors pay for crash protection; a common measure is 25-delta put IV minus 25-delta call IV. Steep skew means put credit spreads collect more than call credit spreads at the same distance.
Expected move for N days
Expected move (1 standard deviation) = Price x IV x square root(days / 365)
Use it for every expiry you trade and compare it with your strike distances.
Strategy by regime
| Regime | Typical reading | Strategy family that fits | Why |
|---|---|---|---|
| Elevated IV | IVR and IVP above about 50 | Credit spreads, iron condors, short strangles (defined risk preferred) | Premium is rich; if IV falls back, short vega gains |
| Low IV | IVR and IVP below about 30 | Debit spreads, calendars, long options with longer expiries | Premium is cheap; long vega gains if IV rises |
| Backwardated term structure | Front IV well above back IV | Calendars are cheap; selling the front month around events | The front contract decays and its IV usually collapses after the event |
| Steep put skew | 25-delta put IV far above call IV | Put credit spreads, collars financed by puts | You sell the expensive side |
This table is a filter, not a signal; elevated IV is usually elevated for a reason.
Worked example
Hypothetical example: a stock trades at $100. Its 30-day IV is 28 percent. Over the past 52 weeks the IV30 low was 16 percent and the high was 56 percent (a one-week spike). On 180 of the last 252 trading days IV30 was below 28 percent.
Step 1, IV rank: (28 - 16) / (56 - 16) = 12 / 40 = 0.30, so IVR = 30.
Step 2, IV percentile: 180 / 252 = 0.714, so IVP = 71.
Step 3, interpretation: the spike distorts IVR; IVP shows that 28 percent is above normal for this stock. Premium selling is defensible; premium buying is not obviously cheap.
Step 4, term structure: 30-day 28 percent, 60-day 26 percent, 90-day 25 percent: mild backwardation.
Step 5, expected moves: 30 days: 100 x 0.28 x square root(30/365) = 100 x 0.28 x 0.2867 = $8.03. 60 days at 26 percent: 100 x 0.26 x 0.4055 = $10.54. So one standard deviation is roughly 92 to 108 over 30 days and roughly 89.5 to 110.5 over 60 days.
Step 6, skew: 25-delta put IV 32 percent, 25-delta call IV 25 percent; skew is 7 points in favour of puts.
Exclusions: fees, dividends and interest; the formula assumes normally distributed returns, which real markets violate, especially on the downside.
Common mistake
Practice activity
On paper: an index ETF trades at $400 with IV30 of 18 percent. The 52-week IV30 low is 11 percent and the high is 39 percent. IV30 was below 18 percent on 95 of the last 250 trading days. Calculate IVR, IVP and the 45-day expected move, then state which strategy family the regime table suggests.
Show solution
IVR = (18 - 11) / (39 - 11) = 7 / 28 = 0.25, so 25. IVP = 95 / 250 = 0.38, so 38. Expected 45-day move = 400 x 0.18 x square root(45/365) = 400 x 0.18 x 0.3511 = $25.28, about 375 to 425.
Both measures are below 50: a low-to-middle regime. The table favours debit spreads or calendars; if you still sell premium, expect thin credits and keep size small.
Limitations: one year of history can miss a whole regime, and a change in the underlying's business can make its history irrelevant.
Key takeaways
- IV rank compares today's IV with the 52-week range; IV percentile compares it with the distribution of days. Use both.
- Term structure (IV by expiry) and skew (IV by strike) tell you where premium is rich: before events, and on the put side.
- Recompute the expected move for the exact expiry you trade and compare it with your strike distances.
- Match strategy family to regime: sell premium when IV is elevated, buy it when IV is cheap, and never judge IV without the underlying's own history.
Next step
Next you will put numbers on the most-used two-leg structures: debit and credit vertical spreads, including probability of profit and expected value.
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