When we are trading in options, specially with option strategies , correct understanding of implied volatility is must. A non-directional option trader is trying to earn profits through decay in option premiums and it is extremely important that trade is initiated when premiums are high.
When will the option premiums be high ? Option premiums of all the options will increase whenever there is more uncertainty in the scrip or in the market as a whole. Due to this uncertainty (which may be because of various reasons) , there will be a good increase in the premiums for both the options across different strikes. This is very clearly reflected by increase in Implied Volatility values as these values are directly proportional to the value ofpremium in the option. And hence provide a great opportunity for option writers to write options.
Once the event because of which there was increase in Implied Volatility is over, there will be a sharp decrease in values of implied volatility and in the premiums of options. This is what option writer wants. He would write options at a much higher value and square off his trades at a much lower value, thereby booking profits in his trade.
So golden rule is sell high implied volatilities and buy low implied volatilities.
Now a good option trader must develop capabilities to identify what value of Implied Volatilityis high and what value is low. This requires experience and a plan to trade for events so that right kind of trade is executed.
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