Chapter 36: The Basics of Volatility Trading 135 
might not seem all that attractive. That is, if the first percentile of XYZ options were 
at an implied volatility reading of 39% and the 100th percentile were at 45%, then a 
reading of 40% is really quite mundane. There just wouldn't be much room for 
implied volatility to increase on an absolute basis. Even if it rose to the 100th per­
centile, an individual XYZ option wouldn't gain much value, because its implied 
volatility would only be increasing from about 40% to 45%. 
However, if the distribution of past implied volatility is wide, then one can truly 
say the options are cheap if they are currently in a low percentile. Suppose, rather 
than the tight range described above, that the range of past implied volatilities for 
XYZ instead stretched from 35% to 90% - that the first percentile for XYZ implied 
volatility was at 35% and the 100th percentile was at 90%. Now, if the current read­
ing is 40%, there is a large range above the current reading into which the options 
could trade, thereby potentially increasing the value of the options if implied volatil­
ity moved up to the higher percentiles. 
What this means, as a practical matter, is that one not only needs to know the 
current percentile of implied volatility, but he also needs to know the range of num­
bers over which that percentile was derived. If the range is wide, then an extreme 
percentile truly represents a cheap or expensive option. But if the range is tight, then 
one should probably not be overly concerned with the current percentile of implied 
volatility. 
Another facet of implied volatility that is often overlooked is how it ranges with 
respect to the time left in the option. This is particularly important for traders of 
LEAPS (long-term) options, for the range of implied volatility of a LEAPS option will 
not be as great as that of a short-term option. In order to demonstrate this, the 
implied volatilities of $OEX options, both regular and LEAPS, were charted over 
several years. The resulting scatter diagram is shown in Figure 36-3. 
Two curved lines are drawn on Figure 36-3. They contain most of the data 
points. One can see from these lines that the range of implied volatility for near-term 
options is greater than it is for longer-term options. For example, the implied volatil­
ity readings on the far left of the scatter diagram range from about 14% to nearly 40% 
(ignore the one outlying point). However, for longer-term options of 24 months or 
more, the range is about 17% to 32%. While $0EX options have their own idiosyn­
cracies, this scatter diagram is fairly typical of what we would see for any stock or 
index option. 
One conclusion that we can draw from this is that LEAPS option implied 
volatilities just don't change nearly as much as those of short-term options. That can 
be an important piece of information for a LEAPS option trader especially if he is 
comparing the LEAPS implied volatility with a composite implied volatility or with 
the historical volatility of the underlying.