You now have a shelf of structures. The last job in this module is picking one. Three questions decide it, and every one is a number you can read off the Terminal before you place a trade.
Is implied volatility high or low for this stock?
Not high against another stock; high against its own history. The one-year IV percentile says what share of the past year's daily readings sat below today's. Above 70 the options are expensive by the stock's own standards, and the edge is in selling them. Below 30 they are cheap, and the edge is in owning them. Between 30 and 70 volatility on its own is not a reason to trade, so a structure has to earn its keep from direction or from the term structure instead.
Expensive is not the same as wrong. Implied volatility is high after a sell-off because the stock really is moving more. The percentile tells you the price is high; you still need a reason to think the movement will fade. That is why the next two questions matter.
What shape is the term structure?
Compare the front month's at-the-money IV with the back's. Upward, back above front, is the resting state and says nothing urgent. Inverted, front above back, says the market is paying up for the near term: an event, or a stock under stress. An inverted curve favors structures that sell the front and own the back. An upward one says a calendar is paying for the back's extra vol, so use it only when you think that extra is too small, and otherwise leave calendars alone.
Is there an event before expiration?
Earnings, a product day, a court ruling. An event inside the front month means the front vol is a bet on the event, not on ordinary movement, and it collapses the morning after. Sell it only with wings or a back-month hedge behind it. Own it only if you believe the move will be larger than the straddle says.
An upward curve with an earnings date on day 25. Drag front-month volatility high with no event to see a stressed, inverted curve; drag the earnings move up to see an event bump. Each shape points to a different row of the table.
Play with both sliders and you can build every row of the table below: a flat, calm curve; a high front with no event, the stress case; and a bump from an earnings date that the back months hardly feel.
The table
| IV percentile | Term structure | Event ahead | Structure that fits |
|---|---|---|---|
| Over 70 | Upward | No | Iron condor or butterfly: short vol with a floor |
| Over 70 | Inverted | Yes | Long calendar through the event, or an iron fly at the event expiration |
| Under 30 | Upward | No | Long straddle or strangle, or a backspread if you also have a direction |
| Under 30 | Inverted | Yes | Long straddle into the event, sized by the straddle's implied move |
| 30 to 70 | Any | Either | Trade direction with a ratio or a vertical, or wait |
The table is a starting point, not a rule. Two more checks come before any of these.
Check one: the move against the price
Compare the straddle, the market's price of movement, with the one-standard-deviation move you compute from the IV, the stock price and the time: price times IV times the square root of days over 365. An at-the-money straddle prices in about 0.8 of one standard deviation, so the two should sit close. The chart shows what that standard deviation means as a range of prices at expiry.
Where a $100 stock at 30% volatility is likely to finish in 30 days. The note prints the 1 and 2 sigma ranges. An at-the-money straddle costs about 0.8 of the one-sigma distance; raise volatility or days and both widen together.
About two times in three the stock finishes inside the darker band. A short condor with its short strikes near the edges of that band is betting on exactly that; a long strangle with strikes there is betting on the other one time in three, and needs the move to go past the strikes by the premium paid. If the straddle looks large against the moves the stock has actually made, that is the short-vol case in one line.
Check two: the worst day
Check that the maximum loss is a size you can carry through the worst day, which is why the defined-risk rows come first in the table. A condor tells you its worst case before you trade. A short straddle or a ratio spread does not, and the worst day is usually the one when volatility jumps too.
The maths: one sigma, the straddle and a worked check
The one-standard-deviation move to expiry is σ$ = S × v × √(d / 365), where S is the stock price, v the at-the-money IV as a decimal and d the days to expiry. An at-the-money straddle is worth about 0.8 × σ$, since 0.8 is close to √(2/π), the average size of a standard normal move.
Worked example: stock $230, IV 28%, 30 days. √(30/365) is 0.287, so σ$ = 230 × 0.28 × 0.287 = $18.47, and a fair straddle is about 0.8 × 18.47 = $14.78. If the chain shows the straddle at $14.80, the market is pricing movement in line with its own IV. If the stock has been realizing 18% for months, the same arithmetic at 18% gives a σ$ of $11.87 and a straddle worth $9.50 on that history, well under $14.80, which is the case for selling it with wings.
Your turn
Take AAPL today. Read its IV percentile on the Options Dashboard. Compare the front and back at-the-money vols on the term chart. Compute the one-sigma move to the monthly expiration and set it beside the straddle. The tasks below walk through exactly that, and the last one asks you to pick the row.