Section 11 - Chapter 3 - Options Derived Volatility

Section 11 - Chapter 3 - Options Derived Volatilityn - Presented by Rohan Sharma - The CMT Coach - Chartered Market Technician CMT Level 1 Study Material - CMT Level 1 Chapter Wise Short Notes - CMT Level 1 Course Content - CMT Level 1 2025 Exam Syllabus Visit Site : www.learn.ptaindia.com and www.ptaindia.com

1. Chapter 3 - Options Derived Volatility Section 11 – Volatility Analysis Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

2. Agenda Options Derived Volatility Calculation of Implied Volatility Application to Price Movements Introduction to VIX VIX through Bull and Bear Cycles VIX and Seasonality Various Published VIX Indexes What Causes VIX Spikes Using VIX for Signals This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

3. Implied Volatility (IV) Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

4. Implied Volatility (IV)? 📌 What is Implied Volatility (IV)? • IV represents the market's expectation of future price movement in a stock or option. • Expressed as a percentage, IV estimates how much an asset could move, but not the direction of movement. • Higher IV → Expect larger price swings (higher risk). • Lower IV → Expect smaller price swings (lower risk). • IV is derived from option prices using the Black-Scholes model or other pricing models . Key Facts About IV ✅ Forward-Looking → Based on market expectations, not historical data. ✅ Mean-Reverting → IV tends to return to its average over time. ✅ Higher in Uncertainty → Spikes during earnings, news, or market crashes. ✅ Lower in Stability → Falls in calm, predictable markets. ✅ Impacts Option Prices → Higher IV = More expensive options; Lower IV = Cheaper options .

5. Implied Volatility (IV)? 📌 IV & Option Pricing Relationship . • Call & Put Options: o Higher IV → Increases both Call & Put prices. o Lower IV → Decreases both Call & Put prices. • Effects on Different Strikes: o OTM (Out of the Money) options: Most sensitive to IV changes. o ATM (At the Money) options: Moderately affected. o ITM (In the Money) options: Least affected . IV Comparisons Factor High IV Low IV Market Sentiment Uncertainty, fear, speculation Stability, confidence Option Premiums Expensive options Cheaper options Earnings Events Typically before earnings Post-earnings drop Market Crashes IV spikes (VIX rises) IV falls in calm periods Strategy Preference Selling options (IV crush) Buying options (IV expansion)

6. Implied Volatility (IV)? 📌 How to Interpret IV ? • High IV: Market expects large price swings → Good for selling options (IV likely to drop). • Low IV: Market expects little movement → Good for buying options (IV may rise). • IV Rank (IVR) & IV Percentile (IVP): o IV Rank (IVR): Current IV compared to past 1-year range (0-100 scale). o IV Percentile (IVP): Percentage of days in the last year where IV was lower than today’s IV. o IVR & IVP > 50% → IV is high (better to sell options). o IVR & IVP < 50% → IV is low (better to buy options).

7. Implied Volatility (IV)? 📌 How to Interpret IV ? • High IV: Market expects large price swings → Good for selling options (IV likely to drop). • Low IV: Market expects little movement → Good for buying options (IV may rise). • IV Rank (IVR) & IV Percentile (IVP): o IV Rank (IVR): Current IV compared to past 1-year range (0-100 scale). o IV Percentile (IVP): Percentage of days in the last year where IV was lower than today’s IV. o IVR & IVP > 50% → IV is high (better to sell options). o IVR & IVP < 50% → IV is low (better to buy options).

8. Implied Volatility (IV) & Price Movements Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

9. Implied Volatility (IV)? 📌 1. Key Facts About Implied Volatility & Price Movements ✅ IV Measures Expected Volatility, Not Direction → High IV means large price swings, but doesn’t indicate if price will go up or down. ✅ IV & Stock Price Often Have an Inverse Relationship → When stock price rises, IV tends to decrease, and when stock price falls, IV tends to increase (but not always). ✅ IV Spikes Before Major Events → Earnings, economic data, and news cause IV to rise as uncertainty increases. ✅ IV Crush Happens Post-Event → After an event, IV drops sharply as uncertainty is resolved. ✅ IV Impacts Option Prices → Higher IV = More expensive options, Lower IV = Cheaper options. ✅ Historical Volatility (HV) vs. Implied Volatility (IV) → HV is based on past price movements; IV is forward-looking based on market expectations.

10. Implied Volatility (IV)? 📌 IV & Price Movement Comparisons Scenario Stock Price Movement Effect on IV Why? Earnings or Major Event Coming Uncertain IV Increases Traders expect big price swings. Earnings Just Released Moves up/down IV Decreases (IV Crush) Uncertainty is gone. Stock Rallies Steadily Moves Up IV Decreases Less fear, stable movement. Stock Crashes Moves Down IV Increases Fear rises, uncertainty increases. Market Sell-Off (Panic Selling) Sharp Drop IV Spikes Higher demand for protection (puts). Stock Trading Sideways Low Volatility IV Decreases No expected movement. Sudden News Announcement Moves up/down IV Spikes Uncertainty increases.

11. Implied Volatility (IV)? 📌 Interpreting IV for Trading Decisions 🔹 When IV is HIGH (> 50% IV Rank or IV Percentile): • Market expects large moves. • Options are expensive → Favor option selling strategies (Iron Condor, Credit Spreads, Short Straddles). • Stocks with high IV may have a big drop in IV after an event (IV Crush). 💡 Example: • Tesla (TSLA) IV rises before earnings → Options expensive. • After earnings, IV drops → Options lose value due to IV Crush. • Best trade: Sell options before earnings, buy after earnings.

12. Implied Volatility (IV)? 📌 🔹 When IV is LOW (< 30% IV Rank or IV Percentile): • Market expects small moves. • Options are cheap → Favor option buying strategies (Straddles, Strangles, Debit Spreads). • Good time to buy options before expected IV increase (before earnings season, before news). 💡 Example: • Apple (AAPL) has low IV before a product launch. • Expecting IV to rise, buy options early. • As IV increases, option prices rise even if the stock doesn’t move much.

13. Implied Volatility (IV)? 📌 🔹 When IV is LOW (< 30% IV Rank or IV Percentile): • Market expects small moves. • Options are cheap → Favor option buying strategies (Straddles, Strangles, Debit Spreads). • Good time to buy options before expected IV increase (before earnings season, before news). 💡 Example: • Apple (AAPL) has low IV before a product launch. • Expecting IV to rise, buy options early. • As IV increases, option prices rise even if the stock doesn’t move much.

14. VIX Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia

15. VIX 📌 1. What is the VIX? • VIX (CBOE Volatility Index) is known as the "Fear Gauge" of the stock market. • Measures the 30-day expected volatility of the S&P 500 based on option prices. • Expressed as an annualized percentage (e.g., VIX = 20 means the S&P 500 is expected to move ±20% annually). • Higher VIX → More uncertainty & fear • Lower VIX → Market stability & confidence Key Facts About the VIX ✅ Inverse Relationship with Stocks → Typically, VIX rises when the S&P 500 falls. ✅ Mean-Reverting → VIX tends to return to its long-term average (~18-20). ✅ Spike During Crashes → VIX jumps during market sell-offs, recessions, or crises. ✅ Low in Bull Markets → VIX remains subdued during prolonged market uptrends. ✅ Measured Using S&P 500 Options → Uses implied volatility from near-term options. ✅ Traded via ETFs & Futures → Can be traded using VIX futures, ETFs (e.g., VXX, UVXY ).

16. VIX 📌 VIX Comparisons: Bull vs. Bear Markets Market Cycle VIX Level Market Sentiment Volatility Trading Implication Bull Market < 20 Optimism, stability Low Favor stocks, low volatility strategies (covered calls, debit spreads) Sideways Market 15-25 Uncertain, mixed sentiment Moderate Use range-bound strategies (iron condors, butterflies) Bear Market > 25 Fear, pessimism High Favor volatility strategies (long puts, straddles, hedging with VIX calls) Market Crash (Panic Selling) > 40+ Extreme fear, uncertainty Very High Consider buying VIX calls or hedging with SPY puts

17. VIX 📌 VIX Trading Strategies Based on Market Conditions VIX Level Market Condition Best Strategy Example Trade < 15 (Very Low VIX) Strong Bull Market Sell options (Iron Condors, Credit Spreads) Sell covered calls on SPY 15-25 (Moderate VIX) Normal Market Range-bound trading (Butterflies, Iron Condors) Buy SPY straddle if expecting a move 25-40 (High VIX) Bear Market Hedge portfolio (Buy Puts, VIX Calls) Buy VIX Calls if expecting more fear 40+ (Extreme VIX) Market Crash Play volatility spikes (VIX Calls, Long Puts) Buy UVXY or VIXY for volatility exposure

18. VIX & Seasonality 📌 What is VIX Seasonality? • VIX seasonality refers to the recurring patterns in the Volatility Index (VIX) throughout the year due to predictable market cycles. • Some months historically experience higher volatility than others due to factors like earnings cycles, economic reports, and geopolitical events. • Traders use VIX seasonality to anticipate volatility spikes and adjust strategies accordingly. Key Facts About VIX Seasonality ✅ VIX Tends to Be Lower in Q1 & Q2 → Market optimism and stable trends. ✅ VIX Spikes Are Common in Late Summer & Fall → Due to market corrections and macroeconomic risks. ✅ September & October See the Highest Volatility → Historical market crashes often occur in these months. ✅ December Tends to Have the Lowest VIX → Holiday rally and reduced trading volume. ✅ Earnings Seasons (January, April, July, October) Can Cause Temporary Volatility → Increased uncertainty leads to short-term VIX spikes .

19. VIX & Seasonality 📌 Key Facts About VIX Seasonality ✅ VIX Tends to Be Lower in Q1 & Q2 → Market optimism and stable trends. ✅ VIX Spikes Are Common in Late Summer & Fall → Due to market corrections and macroeconomic risks. ✅ September & October See the Highest Volatility → Historical market crashes often occur in these months. ✅ December Tends to Have the Lowest VIX → Holiday rally and reduced trading volume. ✅ Earnings Seasons (January, April, July, October) Can Cause Temporary Volatility → Increased uncertainty leads to short-term VIX spikes.

20. VIX & Seasonality 📌 VIX Seasonality Comparison by Month Month Historical VIX Behavior Market Trend Trading Implication January Moderate VIX New Year optimism, earnings season Watch for earnings-driven volatility February Slightly lower VIX Post-earnings stabilization Low volatility, favor credit spreads March-April Low to moderate VIX Spring rally, earnings season Favor long equity positions May Moderate increase "Sell in May and Go Away" effect Watch for early summer corrections June-July Relatively low VIX Summer doldrums, light trading Favor low-volatility strategies August VIX begins to rise Market correction risk increases Prepare for volatility spikes September Historically high VIX Market corrections, macro risks Hedge with VIX calls or SPY puts October VIX peaks Crash risk (historical crashes) Volatility trading opportunities November VIX declines Pre-holiday rally Favor long stock positions December Lowest VIX Santa Claus rally, low volume Sell volatility, use Iron Condors

21. VIX Indexes The VIX (Volatility Index) family includes multiple volatility-related indexes published by Cboe Global Markets. Each one measures different aspects of volatility across various asset classes, timeframes, and products . Key Facts About VIX Indexes ✅ Not Just One VIX → Cboe publishes multiple VIX-related indices tracking different asset classes. ✅ Standard VIX = S&P 500 Volatility → The most widely used fear gauge. ✅ Short-Term vs. Long-Term VIX → Different indexes track volatility expectations for various time horizons. ✅ Sector-Specific VIX → Volatility indexes exist for Tech, Energy, Gold, and more. ✅ Volatility of Volatility (VVIX) → Tracks the implied volatility of the VIX itself.

22. VIX Indexes Comparison of Various VIX Indexes VIX Index Measures Focus Common Use Case VIX ( Cboe Volatility Index) 30-day implied volatility of S&P 500 General market risk "Fear gauge" for broad market sentiment VIX9D (9-Day VIX) 9-day S&P 500 implied volatility Short-term market sentiment Trading ultra-short-term risk VIX3M (3-Month VIX) 3-month S&P 500 implied volatility Mid-term risk expectations Portfolio hedging, trend analysis VIX6M (6-Month VIX) 6-month S&P 500 implied volatility Longer-term risk expectations Longer-term hedging strategies VVIX (Volatility of VIX) Expected volatility of the VIX itself Volatility of volatility Helps gauge big moves in the VIX SKEW Index Tail risk (extreme downside moves) in S&P 500 Measures black swan risk Higher SKEW = higher crash risk

23. VIX Indexes Comparison of Various VIX Indexes VIX Index Measures Focus Common Use Case VXAPL (Apple VIX) 30-day implied volatility of AAPL options Individual stock risk Expected volatility of Apple stock VXGS (Goldman Sachs VIX) 30-day implied volatility of GS options Banking sector volatility Measures risk in financial stocks VXGOG (Google VIX) 30-day implied volatility of Alphabet (GOOGL) options Tech sector volatility Expected volatility in Google stock VXN (Nasdaq-100 VIX) 30-day implied volatility of Nasdaq-100 (NDX) Tech stock volatility Measures risk in growth stocks

24. VIX Indexes Comparison of Various VIX Indexes VIX Index Measures Focus Common Use Case VXD (Dow Jones VIX) 30-day implied volatility of Dow 30 stocks Blue-chip stock risk Measures volatility in large-cap stocks RVX (Russell 2000 VIX) 30-day implied volatility of Russell 2000 Small-cap stock risk Measures volatility in small-cap stocks GVZ (Gold VIX) 30-day implied volatility of Gold ETF (GLD) options Gold market volatility Expected volatility in gold prices OVX (Oil VIX) 30-day implied volatility of Oil ETF (USO) options Crude oil volatility Expected volatility in oil prices EVZ (Euro VIX) 30-day implied volatility of Euro-to-USD options Forex volatility Expected volatility in the EUR/USD pair

25. VIX Indexes What Causes VIX Spikes? The VIX (Volatility Index) spikes when market uncertainty, fear, or risk increases. It measures the 30-day expected volatility of the S&P 500 based on options pricing. A sudden rise in VIX signals increased demand for protection via options, usually due to unexpected events or major market shifts. 1. Key Facts About VIX Spikes ✅ VIX Moves Inversely to the Market → When stocks fall sharply, VIX rises. ✅ Sudden VIX Spikes Mean Panic → A rapid increase usually signals market stress. ✅ Not All VIX Spikes Are the Same → Some are short-term (event-driven), others are long-term (structural shifts). ✅ High VIX Often Means a Market Bottom Is Near → Extreme fear can indicate oversold conditions. ✅ VIX Spikes Are Often Short-Lived → The VIX is mean-reverting; extreme spikes usually don't last long .

26. VIX Indexes What Causes VIX Spikes? Cause Why It Causes a VIX Spike Example Events Stock Market Sell-Offs Increased uncertainty leads to higher demand for protection (puts). 2008 Financial Crisis, 2020 COVID Crash Black Swan Events Unexpected, extreme events create panic. 9/11 Attacks, Russia-Ukraine War Economic Data Surprises Bad job reports, inflation spikes, or weak GDP growth create fear. High CPI Inflation Reports (2022) Federal Reserve Decisions Rate hikes, policy shifts increase volatility. 2013 Taper Tantrum, 2022 Rate Hikes Geopolitical Risks Wars, trade tensions, or global instability create uncertainty. US-China Trade War (2018), Russia-Ukraine Conflict (2022) Corporate Earnings Surprises Large-cap companies missing earnings estimates affect overall sentiment. Meta (FB) Stock Drop (2022) High Inflation & Interest Rate Risks Rising costs or aggressive Fed actions create uncertainty. 2022 Inflation & Fed Tightening Cycle Bond Market Stress Rising yields or yield curve inversion indicate recession fears. 2018 Yield Curve Inversion Debt Crises & Credit Events Sovereign or corporate debt defaults increase systemic risk. 2011 European Debt Crisis, Evergrande (2021) Market Liquidity Crunch Forced selling, margin calls cause panic. 2008 Lehman Collapse, 2020 COVID Crash Option Expiry & Dealer Positioning Options dealers hedging positions can amplify VIX movements. Quadruple Witching Events

27. VIX Indexes Using VIX for Market Signals Key Facts About Using VIX for Market Signals ✅ VIX & the S&P 500 move inversely → Rising VIX = Falling stocks, Falling VIX = Rising stocks. ✅ Extreme VIX levels signal turning points → High VIX often precedes market bottoms, low VIX can signal complacency. ✅ VIX Mean Reverts → It spikes during crises but eventually returns to normal levels. ✅ Short-Term vs. Long-Term VIX Trends Matter → A brief spike differs from sustained high volatility. ✅ VIX Can Confirm or Diverge from Price Action → A falling market with a stable VIX suggests limited fear .

28. VIX Indexes Using VIX for Market Signals Interpreting VIX Levels for Market Signals VIX Level Market Sentiment Stock Market Implication Trading Strategy Below 12 Extreme complacency Market may be overbought; risk of correction Hedge with VIX calls or buy puts on SPY 12 - 20 Low fear Normal market conditions, stable uptrend Trend-following, long equities 20 - 30 Moderate fear Market uncertainty, possible corrections Hedge portfolios, buy protection 30 - 50 High fear Market downturns, potential panic selling Buy VIX calls, SPY puts, or go long volatility Above 50 Extreme panic Market crash or systemic crisis Wait for stabilization, prepare to buy stocks

29. Chapter 1 Introduction to Quantitative Methods Next Section 12 – Systems & Quantitative Methods Presented By : This Content is Copyright Reserved Rights Copyright 2025@PTAIndia