I treat implied volatility (IV) as a guide to option prices – not market direction. Before buying an option, I check IV against its past levels, actual price swings and upcoming events. Getting the direction right may not be enough if IV falls.
Here’s my checklist:
- Bull markets: IV is often lower or steadier, but earnings can still cause spikes.
- Bear markets: IV is often higher as demand for protection grows. That does not guarantee more falls.
- Option prices: Higher IV lifts both call and put prices, all else equal.
- Before trading: I compare IV history, differences across strikes and expiry dates, and event risk.
- Risk limits: I set position size and exits first, checking contract size and converting potential losses into S$.
<u>Low IV does not mean low risk.</u> For example, a 1% risk limit on a S$10,000 account means planning for no more than S$100 at risk – not simply buying S$100 worth of options.
Quick Comparison
| What I check | Bull market | Bear market |
|---|---|---|
| Typical IV | Lower or steadier | Higher; can stay high after shocks |
| Priced-in swings | Usually smaller | Usually larger |
| Sentiment | Confidence; possible complacency | Fear and uncertainty |
| Demand for downside protection | Often lower | Often higher |
| Put pricing across strikes | Downside protection can still cost more | Often more costly, though patterns vary |
| Main trap | Mistaking calm for safety | Mistaking high IV for a forecast of falls |
How Implied Volatility Affects Option Prices
Implied volatility (IV) is the annualised move implied by current option prices under a pricing model such as Black–Scholes. That implied move changes across systematic trading cycles as sentiment, event risk and demand for hedging shift. You can see its effect in the prices of both calls and puts.
IV Measures Priced-In Movement, Not Direction
IV measures the size of potential price swings – not their direction. Realised volatility, by contrast, measures actual price fluctuations over a past period.
IV also reflects risk premia and supply and demand. When traders want more downside protection, for example, demand for puts can increase and push IV higher. Think of IV as the market price of uncertainty, not a pure forecast.
Before earnings, IV often rises as the event approaches and fewer days remain to expiry; check whether the expiry includes the announcement before reading the spike.
How IV Changes Call and Put Values
Higher IV increases both call and put prices; lower IV reduces them, all else equal. Vega measures how much an option’s price changes for a 1-percentage-point move in IV. The underlying price, time to expiry and other pricing inputs still matter.
To compare current IV with its own history, use IV Rank or IV Percentile. IV Percentile shows how high today’s reading is relative to past readings. On its own, though, it cannot tell you whether an option is overpriced or underpriced. These pricing effects help explain why IV behaves differently in bull and bear markets.
sbb-itb-466c9b0
Bull vs Bear Markets: IV and Sentiment
The same implied volatility (IV) can point to different sentiment depending on whether markets are calm or under stress.
Bull Markets: Lower IV and Event Risk
In stable bull markets, equity IV is often lower or steadier. This reflects confidence, not certainty, alongside weaker demand for puts. But complacency can creep in. Earnings can also push a stock’s IV above the broader market, especially for options closest to expiry.
Bear Markets: Higher IV and Hedging Demand
After a sell-off, IV often stays high because volatility clusters: large moves tend to follow large moves. Fear and stronger demand for hedging can keep IV high, making out-of-the-money puts more expensive than comparable out-of-the-money calls.
Downside skew does not widen in every sell-off. And high IV signals larger expected swings – not a guarantee of further falls.
Master Systematic Trading with Collin Seow
Learn proven trading strategies, improve your market timing, and achieve financial success with our expert-led courses and resources.
Bull vs Bear Markets at a Glance
These patterns are clearest at the index level. Individual stock picks can behave differently around events.
| Factor | Bull market | Bear market |
|---|---|---|
| Typical IV | Lower or steadier; event spikes possible | Higher; may stay high after shocks |
| Priced-in movement | Smaller expected swings | Larger expected swings |
| Sentiment | Confidence; possible complacency | Fear and greater uncertainty |
| Hedging demand | Often less demand for downside protection | Often stronger demand for downside protection |
| Downside skew | Often present even in calmer conditions | Often pronounced, but changes vary by sell-off |
| Main risk | Treating low IV as safety | Treating high IV as a bearish forecast |
As a rough guide, VIX often sits above 30 during stress and around 15–25 in calmer conditions.
For individual stocks, compare current IV with the stock’s own history and nearby expiries before relying on the bull or bear market label.
A Step-by-Step Process for Assessing IV
Once you understand how IV affects option prices, use these checks to assess whether options are priced high or low before entering a trade.
Check Market Regime, IV History, Skew and Expiry
Start by identifying the market regime. Then compare current IV with its historical range, realised volatility and IV across nearby expiries.
Check the term structure, strike skew and scheduled events before choosing a contract. Look at whether changing sentiment or upcoming calendar events are driving IV.
Track Sentiment Changes and Falling IV
Watch for shifts in sentiment as fear eases or uncertainty clears. IV can fall sharply after major events, leaving a long option trade at a loss even when you get the market direction right.
Set Position Size and Risk Limits Before Entry
Set your position size, loss limit and time-based exit before entering the trade. Use defined-risk structures, such as vertical spreads or iron condors, and limit each trade to 1% to 2% of capital.
Around high-volatility events, cut your position size by 30% to 50%. Price gaps can skip stop levels, so a stop alone may not keep losses within your limit.
For Singapore traders, check the contract multiplier and convert exposure and losses into S$ when sizing the trade.
Conclusion: Look Beyond Bull and Bear Labels
Higher IV lifts option prices, but price moves and time decay can still wipe out gains.
High IV isn’t a bearish forecast, and low IV doesn’t mean safety.
Look past the label. Compare IV history, realised volatility, skew, term structure and event risk before deciding your trade size and loss limits. Read IV as a pricing signal, not a market verdict.
FAQs
How can I tell if high IV is justified?
Compare implied volatility (IV) with realised volatility (RV) and historical averages. If IV is well above your RV forecast, options are likely overpriced. That gap suggests the high IV may not be justified – and could offer a chance to sell volatility.
An IV Rank above 70–80 indicates that IV is high relative to its yearly range.
Can IV rise while share prices climb?
Yes. Implied volatility (IV) reflects uncertainty about future price movements – not the current price direction. Before major events, such as earnings announcements, investors may hedge their positions or speculate on surprises. This can push IV and option premiums higher even while share prices climb.
Collin Seow Trading Academy offers resources to help you understand these patterns and navigate shifts in volatility, with the aim of improving trading outcomes.
How do I size an options trade in S$?
Limit your risk to 1–2% of total capital per trade. For a S$50,000 portfolio, that means risking S$500–S$1,000 per position. When volatility is high, such as during earnings season, reduce position sizes by 30–50%.
You can also use Average True Range (ATR) to size your positions: Position Size = Risk Amount / (ATR × Stop Distance). Adjust your position size to suit your risk tolerance and the trade’s risk-reward profile.
