# Volatility Metrics that Can be Screened for Cheap Options Part 2 - Understanding volatility percentile

### Level 2 - Intermediate Vol Trader

## Understanding Volatility Percentile: A Key Tool for Options Traders

In options trading, volatility is a critical factor that can make or break your trades. As traders, we often look at implied volatility (IV) to gauge market expectations of future price movements. However, to truly understand the context of current volatility levels, it's essential to delve into the concept of volatility percentile. In this article, we’ll explore the volatility percentile, why it matters, and how you can use it to make more informed trading decisions.

What is Volatility Percentile?

Volatility percentile is a statistical measure that compares implied volatility to its historical levels over a specified period. It tells you the percentage of time that implied volatility has been lower than its current level. Essentially, it provides a context for whether the current IV is high or low relative to its historical range.

For example, if the IV percentile of a stock is 80%, it means that the current implied volatility is higher than 80% of the historical IV readings for that stock over the selected period. Conversely, if the IV percentile is 20%, the current implied volatility is lower than 80% of historical readings.

### Why Volatility Percentile Matters

**Relative Context**: Volatility percentile offers a relative measure of volatility, helping traders understand if the current IV is high or low compared to past levels. This is crucial because an IV of 30% might be high for one stock but low for another.**Strategic Decisions**: Knowing the volatility percentile can help traders decide which strategies to employ. High volatility percentiles might indicate a good time for strategies like selling options (e.g., covered calls or iron condors), as premiums are richer. Low volatility percentiles could suggest buying options (e.g., long calls or puts) as premiums are cheaper.**Risk Management**: Understanding where the current volatility stands in its historical context can help traders manage risk more effectively. High volatility percentiles can signal potential market turbulence, prompting traders to be more cautious or hedge their positions.

### Calculating Volatility Percentile

To calculate the volatility percentile, follow these steps:

**Gather Historical IV Data**: Collect implied volatility data for your chosen asset over a specific period (e.g., 1 year).**Rank the Data**: Sort the historical IV data from lowest to highest.**Find the Current IV**: Determine the current implied volatility level.**Calculate the Percentile**: Identify the position of the current IV within the ranked data set and calculate its percentile rank.

Here’s a simple formula to determine the percentile:

Percentile=Number of data points below current IV/Total number of data points×100

### Practical Example

Let’s say you’re looking at the implied volatility of XYZ stock over the past year. You have 252 daily IV readings (one for each trading day).

Sort these readings from lowest to highest.

If the current IV is 25%, and there are 201 readings below 25%, the percentile would be:

Percentile=201/252×100≈79.76%

This means the current IV is higher than approximately 80% of the past year’s readings, indicating a relatively high volatility environment.

### Using Volatility Percentile in Your Trading

#### High Volatility Percentile (>70%)

**Strategies**: Consider selling options to capture high premiums. Strategies like iron condors, covered calls, and vertical spreads can benefit from high IV environments.**Caution**: Be aware of potential market events or earnings reports that might be causing high volatility. Adjust your risk management accordingly.

#### Low Volatility Percentile (<30%)

**Strategies**: Look into buying options, as premiums are lower. Long calls, puts, and straddles can be more cost-effective.**Opportunity**: Low volatility can provide opportunities for entering positions with less risk of significant price swings.

### Conclusion

Volatility percentile is a powerful tool that provides context to current implied volatility levels, helping traders make more informed decisions. By incorporating volatility percentiles into your analysis, you can better gauge market conditions, select appropriate trading strategies, and manage risk more effectively.

Stay tuned for more insights and strategies in our upcoming newsletters. As always, happy trading!