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Trying to make sense of the following sentences found in an article

  • High volume and low volatility indicates that option contracts are being sold.
  • High volume and high volatility indicates option contracts are being purchased.

Sold I believe really means selling volume > buying volume and clearly purchased should mean the opposite, buying volume > selling volume.

I don't seem to completely grasp this thing

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    My sophisticated viewpoint would be that the article is bullshit.
    – Fattie
    Jan 5 at 17:10
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It's more accurate to say buying pressure and selling pressure rather than volume, since technically the volume is the same on either side for executed trades (for every buyer there is a seller), and volume in the order book does not necessarily mean more motivation - it just means larger orders. If buyers are more motivated (willing to buy at higher prices), then prices tend to go up, which (all else being equal) means a higher implied volatility from Black-Scholes and similar option models (and vice-versa, high selling pressure can be a cause of lower implied volatility).

Implied Volatility is not directly measurable. It is implied based on the market prices of options, keeping all other variables constant (time to maturity, strike, spot price, and interest rate). So higher selling pressure indirectly lowers IV by lowering the market prices of the options. All else being equal, only changes in market prices can change IV.

It seems a tenuous relationship to me, though. To me, implied volatility represents uncertainty, while buying and selling pressure on options could represent a specific view on the movement of the underlying stock, not necessarily more or less uncertainty. If I think the underling stock is likely to increase, I'm more inclined to buy calls (or sell puts) regardless of implied volatility. It also doesn't take into account options that are hedges (e.g. covered calls) or part of a basket (spreads).

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  • Ok. you are referring to volumes for closed trades/transactions. I meant volumes you seen on the bid and ask sides. Do those statements make sense? Are they correct? With stocks it should be the opposite, volatility rises when selling pressure is higher and this confuses me somewhat.
    – noplace
    Jan 5 at 15:53
  • So bid/ask volume can be an indicator of buy.sell pressure but market orders can push prices in either direction. What do you mean by "volatility rises when selling pressure is higher"? Remember that implied volatility for options is not necessarily equal to the actual volatility of the underlying instrument.
    – D Stanley
    Jan 5 at 15:58
  • Yes, stock market volatility is another thing but I'm used to it. Forget it for now. It was just to say that "High volume and low volatility indicates that option contracts are being sold." is the opposite of what happens with stocks which might explain why I cannot get it completely. In fact I'm even sure this statement is correct.
    – noplace
    Jan 5 at 16:12
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    Hopefully my new 2nd paragraph answers that, but I still think the cause and effect in the article is not as solid as it seems. I have other problems with that article too, but don't want to confuse things too much.
    – D Stanley
    Jan 5 at 16:41
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    VIX can also rise when there is high buying pressure, so the relationships are not comparable. It's also not a direct effect. You can have high stock buying or selling pressure and the VIX does nothing since it's based on option prices (and not the underlying stock prices)
    – D Stanley
    Jan 5 at 17:35
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To reiterate what D Stanley stated, it's more accurate to say that "buying pressure and selling pressure rather than volume." This refers to the buy and sell orders that are being placed rather than volume of contracts traded (there's a buyer for every seller).

To make matters more confusing, if "High volume and low volatility indicates that option contracts are being sold," I would say that the contracts have already been sold and that is why IV is low. At that point, it would be time to buy these contracts because they are cheap and before IV reverts. Would you sell contracts just because they are cheap?

Furthermore, it's just not this simple. Synthetic positions are used to offset IV disparities. If one the put (or the call) of same series options strays from fair value, the market maker will utilize a conversion or a reversal to drive it back to parity.

Or perhaps a trader is just using a synthetic for delta neutral trading?

Or perhaps the large volume in one option is part of a combo order such as a spread? Look for another option with similar large volume.

AFAIC, such statements as found in your article are far too simplistic, ignoring more complex underpinnings, attempting to sound erudite. I would never buy or sell any option based on just a simple comparison of IV and volume. Price is where's it's happening along with your expectations for the underlying.

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  • Agreed on pressure but that was I meant anyway. I'm sure the world is more complex but one still needs to start grasping simpler concepts and move from that. I'm trying to build a simple understanding of what is reasonably happening during a trading day when IV is decreasing. Is it correct to say that it's the options selling pressure that is pushing IV lower?
    – noplace
    Jan 5 at 16:30
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    Yes, I believe that it is correct to say that it's the options selling pressure that is pushing IV lower. However, I think that it would be specious to conclude that you can extrapolate future underlying or option price movement from that information because there are far more complex strategies being executed and one has no idea if that selling pressure is bullish or bearish. Jan 5 at 16:45

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