Happy Monday, traders…

Ben here.

Have you ever picked the right direction on an option trade and still lost money? 

Welcome to the wild world of options trading, where things aren’t always as straightforward as they seem…

So many newbie options traders lose money because they start trading options like stocks, missing the unique factors that drive option pricing.

One of these key nuances is implied volatility (IV), which influences option prices beyond the movement of the underlying stock. 

Understanding IV can be the difference between a game-changing win and an annoying loss. 

It’s not just about picking the right direction — it’s about knowing how the market’s expectations of volatility impact the price of the contracts you’re trading. 

As market conditions fluctuate, so does IV, which can significantly affect your potential profits or losses.

This insight isn’t just beneficial, it’s essential for choosing the right contracts to trade and avoiding costly mistakes. 

With that in mind, let’s break down everything you need to know about IV…

Why IV Matters

Options don’t trade like stocks. Sometimes, you can be right about the direction of an options trade and still lose money.

This is due to a variety of factors that influence option pricing beyond the price of the underlying stock. 

Great options traders approach their trading like a five-star chef prepares a dish. They have a great recipe, but they also measure the ingredients to perfection.

If you don’t consider the ingredients, your dish won’t taste very good (and it’ll cost a lot more than it should).

The same goes for cooking up an options trade. 

In this analogy, your strategy is your recipe … but one of the most important ingredients is how the options are priced.

And IV is at the center of it all…

How IV Works

IV is the estimate of a stock’s future volatility. It reads as a percentage figure attached to options contracts. 

The IV on contracts could be 20%, 50%, or 500% — all depending on the results of a mathematical formula.

The most common formula used to calculate options prices is known as the Black-Scholes model. 

This model combines the option’s market price, the underlying stock price, the strike price, the time to expiration, and the current risk-free interest rate. 

And it’s all to determine the overall IV — and the price — of the contracts.

In short, this means that both puts and calls are more expensive if the contract’s IV is higher. 

On the flip side, if a chart looks like a flat line with few price swings, the IV on those options will be lower.

Where IV Comes From

Implied volatility comes from the marketplace with the bid/ask spread. 

If there’s a lot of buying of options at a certain strike price, IV will start to increase (making the contracts more expensive). 

If there’s a lot of selling of options, IV will start to decrease (making options less expensive). 

You can trade both sides, which is a primary reason why markets are fair and efficient. 

When market demand goes up, IV goes up, increasing the option’s overall value. 

For example, external news-driven events (like an upcoming earnings call) can cause massive swings in the IV on short-dated options contracts.

WARNING: Be cautious about IV crush when trading options around big catalysts.

Why IV Exists

IV exists for market makers (the people who sell options). 

They need incentives to sell swingy contracts that could easily end up deep in the money. 

If someone’s going to sell a highly volatile call option, basic market efficiency calls for that person to be paid more premium for the sale than someone selling a call in a low-volatility stock. 

A perfect example of this is meme stocks like GameStop Corp. (NYSE: GME). Market makers currently have the IV on GME contracts at 5-10x normal levels because they know the risks of selling those options. 

The options market functions much like a casino (but that doesn’t mean you should treat it like one). 

The market makers (who sell you contracts) are the house. The house will give you better odds on a game with less probability of success. 

The house will also happily stiff you with bad odds on a game with a higher probability of success. 

The IV attached to options contracts exists to create this same sort of balance of odds in the options market.

IV is a measurement of human behavior — it’s cyclical and experiences a reliable ebb and flow. Therefore, it’s always fluctuating, which causes options to increase and decrease in value. 

That’s why when you buy or sell options, you need to be aware of and correct about where implied volatility could be going. Otherwise, you could lose money.

So, next time you’re looking over my Spyder Scanner, don’t forget to check the IV of the contracts.

It could make the difference between a game-changing win and an annoying loss.

💰The Biggest Smart-Money Bets of the Day💰

• $8.43 million bullish bet on TSLA 06/21/2024 $185 calls @ $2.66 avg. (seen on 6/14)

• $3.75 million bullish bet on NVDA 06/21/2024 $137 calls @ $1.25 avg. (seen on 6/14)

• $1.5 million bullish bet on AAPL 09/20/2024 $225 calls @ $5.00 avg. (seen on 6/14)

Happy Trading,

Ben Sturgill

P.S. When I’m looking for the best trade opportunities in the options market, the first place I check is my Spyder Scanner…

TODAY, June 17 at 12:00 p.m. EST — I’m hosting an urgent LIVE WEBINAR where I’ll tell some Dad jokes, break down my recent trades, and reveal the most promising ‘smart money’ setups I’m seeing on the scanner today.

I’m excited to see you there — CLICK HERE NOW TO RESERVE YOUR SEAT.