July Office Hours FAQs: Implied Volatility, Position Greeks and Market Maker Order Flow

What is implied volatility?

Every options pricing model uses six inputs: strike price, stock price, time to expiration, prevailing interest rates, any dividends and implied volatility. Implied volatility reflects the market's expectation for how much the stock will move, in either direction, and is embedded in the option's price. Higher implied volatility results in higher option prices, while lower implied volatility results in lower option prices.

How do I know if implied volatility is currently high or low?

Two common statistics, IV Rank and IV Percentile, show how today's implied volatility compares with roughly the past year's levels. This historical context can help guide strategy selection: buying calls or debit call spreads may make more sense when volatility is low, while credit strategies like selling cash-secured puts or credit put spreads may be more attractive when volatility is elevated. Since not every strategy performs the same way in every volatility environment, this context is worth checking before placing a trade.

Where can I compare historical and implied volatility side by side?

The free OIC Historical and Implied Volatility tool overlays a stock's historical volatility against its 30-day implied volatility over roughly the past year, with a table showing the 52-week high and low. That range can help build a rough buy/sell benchmark — for example, if implied volatility has ranged from 11% to 26% over the past year and is currently trading near 14%, it's closer to the low end, suggesting options are relatively inexpensive at that level.

Why are the extrinsic values of same-strike calls and puts so similar?

This comes down to put-call parity, the pricing relationship linking a call, a put at the same strike and the underlying stock. Since a stock position can always be synthetically recreated from a call and a put (a protective put, for example, behaves like a synthetic call), the model prices their extrinsic values very similarly. Comparing extrinsic values on an option chain is a useful way to see this relationship in practice.

How did market makers use order flow on the trading floor compared with today?

On the floor, market makers watched order flow arrive in person and knew which firm the brokers represented, letting them anticipate follow-on orders from the same source. Today, with trading mostly electronic, they instead rely on data like put/call volume and open interest that build over the day — often without knowing whether an order is institutional or retail, though size can be a clue.

Do market makers trade based on news or a directional opinion?

Generally, no. A market maker's role is to post bids and offers across many strikes and names, take the opposite side of whatever the public wants to do, and hedge the resulting position to stay close to market-neutral. Rather than reacting to headlines directly, they respond to order flow itself — adjusting quoted volatility based on buying or selling.

For an earnings play, is it better to buy a call expiring soon or further out?

Weekly expirations make it possible to target an expiration just a few days after earnings, which is typically less expensive than an option one to three months out. That said, options tend to get pricier as earnings approach, since implied volatility rises heading into the event — so timing the purchase matters.

What is "vol crush," and how does it affect an earnings trade?

Once earnings are released, implied volatility often drops sharply — a move known as vol crush — even if the stock moves as expected. Since a long option's value depends on both direction and implied volatility, a sudden drop in volatility can offset some or all of the gain from being right on direction.

Why do the Gamma, Theta and Vega of a collar depend on where the stock is trading relative to the two strikes?

A collar combines a long protective put with a short covered call, so while the position is Delta-neutral at inception, its net Greek exposure shifts with the stock price. Closer to the long put, it behaves more like the owned option: positive Gamma, negative Theta and positive Vega. Closer to the short call, it behaves more like the sold option: negative Gamma, positive Theta and negative Vega. In short, whichever strike the stock is nearer to dominates the position's Greek profile at that moment.

Can Delta be used for a back-of-the-envelope estimate of profit or loss if the stock moves $5?

Yes, as a rough approximation. Multiplying the position's net Delta by the size of the stock move gives an estimated change in value — for example, a spread with 40 net long deltas would be expected to gain roughly $200 if the stock rises $5 (40 x $5 = $200). This assumes all other pricing inputs stay constant; in practice, a stock move is often accompanied by a shift in implied volatility, which affects the position through Vega and can offset some of the Delta-driven gain or loss. For a fuller picture, the OIC Options Calculator can model a position against different stock prices and volatility assumptions.