IV percentile definition and example
IV percentile is defined by the following formula:
Therefore to calculate the IV percentile. You can use the following procedure. You first need to chose a time period. From which you will take the past IV levels. Count the days from this time period. On which the implied volatility was lower than the current IV. Lastly divide this number by the total amount of days in your chosen time frame. To express the result in percentile form multiply this result by 100%.
The example: Imagine that the current implied volatility for XYZ is at 28%. You want to measure the IV percentile for the last 10 days. XYZ volatility levels were as follows for that period: 14% , 15%, 13%, 14%, 14%, 15%, 20%, 26%, 34%, 28%. Note that the last value is the current value. As you can easily tell on 8 days IV was below the current level. There were 10 days in the chosen time frame. Therefore IV percentile is equal to 8/10 * 100% = 80%.
Option IV rank explained
The IV rank is measure of how the current implied volatility compares to maximum and minimum of the chosen period. To calculate it we need to pic a time frame. Find the maximum IV and the minimum values for that period. Then subtract the minimum from current volatility. Finally divide the result by the maximum minus minimum. To convert it to percentage value. Multiply by 100%. Here is the formula for this calculation:
IV percentile vs IV rank: crucial differences
The difference between the IV percentile and IV rank is similar to the difference between the median and mean. The first determines how often lower values of volatility occurred. While the second one measures the relative magnitude of current implied volatility against the historical values. You could think of the first measure as a measure of historical probability. Where as the IV rank measure the “distance” to the extreme values (max and min). Going back to the example data form the first paragraph. The IV rank would be equal to 71.43%. While the IV percentile would be equal to 80%.
Is IV percentile more important
We would like to argue that IV percentile is a more important metric. Because it tells us about the probabilities of events. While IV rank is a simple relation of current volatility. To the magnitude of it’s historical values. However, you will get the best results. When you combine both metrics. To get a better picture of the market situation.