{"id":221849,"date":"2025-04-10T11:12:05","date_gmt":"2025-04-10T15:12:05","guid":{"rendered":"https:\/\/ibkrcampus.com\/campus\/?p=221849"},"modified":"2025-04-10T11:12:08","modified_gmt":"2025-04-10T15:12:08","slug":"16-minute-abs","status":"publish","type":"post","link":"https:\/\/www.interactivebrokers.com\/campus\/podcasts\/ibkr-podcasts\/16-minute-abs\/","title":{"rendered":"16 Minute Abs"},"content":{"rendered":"\n<p>Mat Cashman, Principal of Investor Education at the Options Clearing House, joins IBKR\u2019s Jeff Praissman to discuss the Rule of 16 and how traders can use it in their analysis and decision making.<\/p>\n\n\n\n<figure class=\"wp-block-audio\"><audio controls src=\"https:\/\/www.interactivebrokers.com\/campus\/wp-content\/uploads\/sites\/2\/2025\/04\/pod-20250402-occ_final_disclosures_mixdown.mp3\"><\/audio><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\" id=\"h-summary-ibkr-podcasts-ep-244\">Summary \u2013 IBKR Podcasts Ep. 244<\/h2>\n\n\n\n<p><em>The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made<\/em>.<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>Hello everyone. Welcome to another episode of the Interactive Brokers Podcast, brought to you in partnership with the Options Industry Council and the OCC. I&#8217;m your host, Jeff Praissman. Today we&#8217;re lucky to have as our guest Mat Cashman, Principal of Investor Education at OCC. Mat, welcome. What are we going to discuss today?&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Thanks, Jeff. It&#8217;s great to be here, as always. We are going to discuss the Rule of 16 today. We just wrapped up a webinar on this topic, but we&#8217;re going to use this as an opportunity to dive into it in a more conversational way.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-0\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>Yeah, absolutely. And it was a great webinar \u2014 I highly recommend our listeners go to our website and catch the replay if they weren\u2019t able to join us live. So today we\u2019ll be breaking down the Rule of 16 and how it helps traders interpret implied volatility on a daily level. But like we always do here on the podcast, we\u2019ll take a more conversational deep dive.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-0\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>That&#8217;s right. The webinar laid out the foundations, and I go into some real specifics about how the actual math works behind the scenes. But today, we can break it down a little further and explore how traders use this concept to inform their everyday decision-making.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-1\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>Sounds good. And Mat, let\u2019s start with the basics. Implied volatility \u2014 or IV, as it\u2019s usually referred to \u2014 is really one of the most important concepts in options pricing. At a high level, it represents the market&#8217;s expectations of future price movements.&nbsp;<\/p>\n\n\n\n<p>Here\u2019s the catch: IV is quoted on an annualized basis. That means when we see an option with a 20% implied volatility, it really tells us the market expects a 20% move over the course of a year. But of course, options aren\u2019t usually a year long.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-1\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Yeah, exactly. That\u2019s where the two don\u2019t necessarily line up. Most traders aren\u2019t looking at a full-year time horizon, so they want to understand how much movement is being implied \u2014 maybe on a daily or weekly basis. And that\u2019s where something like the Rule of 16 comes into play.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-2\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>So Mat, before we even break down the Rule of 16, I\u2019d like to quickly touch on standard deviation, because it\u2019s really a key piece of this. For our listeners \u2014 and probably a lot of them know this \u2014 but for those that don\u2019t: in statistics, standard deviation tells us how much something typically deviates from its average over time.&nbsp;<\/p>\n\n\n\n<p>The same idea applies to market prices. One standard deviation represents a range within which prices are expected to move about 68% of the time.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-2\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>That\u2019s right. And when we\u2019re dealing with implied volatility, we\u2019re essentially using option pricing models to estimate the market&#8217;s expectation for future standard deviations of movement. So you\u2019re thinking about how big that range is that covers that 68% of the prices over time.&nbsp;<\/p>\n\n\n\n<p>The tricky part here is converting that annualized volatility \u2014 because implied volatility is an annualized number \u2014 into something more practical that we can think about in terms of standard deviations on a daily basis.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-3\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>And that\u2019s exactly where the Rule of 16 comes in. But I\u2019m thinking to myself \u2014 there\u2019s a scene in <em>There\u2019s Something About Mary<\/em> where a guy is talking about \u201c8-Minute Abs\u201d and he comes up with \u201c7-Minute Abs.\u201d So I\u2019m thinking \u2014 why 16? Why not 14? Why not 12? Why not 20?&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-3\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>I love that. So the number 16 comes from the fact that there are roughly 252 trading days in a year. And if you take the square root of 252, you get about 15.87 \u2014 which we round up to 16 for simplicity. It also just rolls off the tongue \u2014 the Rule of 16.&nbsp;<\/p>\n\n\n\n<p>But that means to estimate the expected daily movement of a stock, you essentially divide its annualized implied volatility by 16. That\u2019s how we get to the daily standard deviation.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-4\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>So just to clarify for our listeners \u2014 if an option\u2019s implied volatility is 20%, we\u2019re going to divide that by 16, which gives us about 1.25% per day.&nbsp;<\/p>\n\n\n\n<p>So if the stock\u2019s trading \u2014 let\u2019s just say \u2014 at $100, that means the market is implying a $1.25 daily move on average.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-4\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Exactly. And the key insight here is that the Rule of 16 really allows traders to take an abstract annualized volatility \u2014 which we just talked about as not particularly relevant to our everyday lives \u2014 and turn that figure into something tangible and digestible on a daily basis. That\u2019s really what we\u2019re looking for here.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-5\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>And Mat, in your webinar you emphasized breaking down the formula into two structural parts \u2014 the numerator and the denominator. Can you explain that?&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-5\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Sure. The numerator I like to think of as the big block of variance. It\u2019s really the implied volatility multiplied by the stock price.&nbsp;<\/p>\n\n\n\n<p>So if you\u2019re looking at an option that has \u2014 in our example \u2014 a 20% volatility and the stock is trading at $100, you would multiply those two things together and you\u2019d get $20 of theoretical movement. But again \u2014 that\u2019s an annual number. It represents the expected movement over the entire year.&nbsp;<\/p>\n\n\n\n<p>Now, the denominator is where we take that big annual expectation \u2014 that big block of variance \u2014 and slice it into smaller, more manageable pieces like daily, weekly, or monthly expectations that you can actually use on a daily basis.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-6\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>So by dividing by 16, we\u2019re essentially chopping the annualized expectations into daily increments.&nbsp;<\/p>\n\n\n\n<p>But going back to my kind of whimsical question \u2014 does this concept only work for daily increments? Or can traders do the \u201c7-Minute Abs\u201d version? Can they use this logic for other time periods?&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-6\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Oh, you can have 7-Minute Abs. You can have 8-Minute Abs. You can have 9-Minute Abs. And that\u2019s a great analogy.&nbsp;<\/p>\n\n\n\n<p>Traders can absolutely extend this concept into different subsets of that annualized number. You can divide by the square root of 52 \u2014 why the square root of 52? Because there are 52 weeks in a year. The square root of 52 is about 7.21 \u2014 that gives you a weekly expectation from that annualized big block of variance.&nbsp;<\/p>\n\n\n\n<p>You could also divide by the square root of 12 \u2014 which is about 3.46 \u2014 and that\u2019ll give you a monthly expectation for how much something might move over the course of a month based on that annualized variance.&nbsp;<\/p>\n\n\n\n<p>But the key here is that you\u2019re really just slicing that big block of variance into different pieces depending on how much of it you want to look at at one point in time.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-7\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>Got it. Got it. And now that we\u2019ve covered the logic, let\u2019s talk about how traders can actually use the Rule of 16 in the real world for analysis and decision-making in their trading strategies.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-7\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Yeah, that\u2019s a great question. Let\u2019s get to where the rubber actually meets the road and stop speaking theoretically. One big use case here is assessing market moves. So let\u2019s look at an example. Let\u2019s say a stock has a 20% implied volatility, and based on the Rule of 16, we\u2019re thinking about its daily standard deviation as about 1.25%.&nbsp;<\/p>\n\n\n\n<p>If one day you walk in and that stock, which was trading at $100, is now trading at $107 for some reason \u2014 that\u2019s a 7% move. Lots of people are going to look at that and say, \u201cWow, that\u2019s a big move.\u201d But you don\u2019t really have a very good framework within which to evaluate how big that move actually is.&nbsp;<\/p>\n\n\n\n<p>What you can do, when you think about it in terms of standard deviations, is look at that and say, \u201cWow, that\u2019s over five standard deviations of a move\u201d \u2014 based on the actual implied volatility where the options were priced beforehand.&nbsp;<\/p>\n\n\n\n<p>A trader might then be able to ask, \u201cIs this a rational move? Is something unusual happening? Or should I be adjusting my expectations going forward?\u201d That\u2019s something I think is a really interesting part of this \u2014 it gives you a framework to evaluate big moves like that when you see them happening.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-8\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>And that \u201csomething unusual,\u201d right, could be a micro or macro event \u2014 such as a micro event like a very specific earnings release, a news announcement, a drug approval by the FDA \u2014 or maybe some bigger-picture, sector-wide or market-wide move, where maybe all the defense stocks are running up, or something like that.&nbsp;<\/p>\n\n\n\n<p>So I guess traders really have to take into account other information when pairing that with those moves.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-8\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Yes, absolutely. For sure.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-9\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>And I would think another great application is really adjusting expectations for different timeframes. So if I\u2019m selling a 30-day option, I might use the Rule of 16 to gauge how much movement I\u2019m pricing into that period.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-9\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Absolutely. That\u2019s a great way to think about it. It\u2019s a really simple but powerful way to frame your expectations and, in turn, make informed trading decisions. Because implied volatilities are directly linked to option prices \u2014 and implied volatilities are directly linked to the standard deviations we\u2019re talking about here.&nbsp;<\/p>\n\n\n\n<p>So it\u2019s something you can use in a real way to frame your expectations for movement.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-10\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>Yeah, Mat, this has been a great discussion. The webinar was great. This podcast has been great. My takeaway is that the Rule of 16 really helps traders make sense of implied volatility on a practical level.&nbsp;<\/p>\n\n\n\n<p>But before we wrap up, are there any final takeaways for our listeners that you\u2019d like to leave?&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-10\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Yeah, absolutely. I think the core message here \u2014 and the key takeaway \u2014 is that implied volatility is an annual number, but you trade in days and weeks.&nbsp;<\/p>\n\n\n\n<p>So the Rule of 16 really helps to bridge that gap between those, so you can think about market expectations in a way that matches however you\u2019re thinking about your trading time horizon. It\u2019s important to be able to match up risk and expectation \u2014 and this helps to bridge that gap.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-11\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>Mat, that\u2019s a perfect summary. Once again, thanks for joining us today on the IBKR Podcast. Mat and the OIC are frequent contributors to the IBKR Campus, and his past webinars, articles, and podcasts can be found on our website under Education. Just click on Campus, scroll to the bottom, and choose the Options Industry Council.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-mat-cashman-nbsp-11\">Mat Cashman&nbsp;<\/h3>\n\n\n\n<p>Thanks for having me, Jeff. It was great to be here today.&nbsp;<\/p>\n\n\n\n<h3 class=\"wp-block-heading\" id=\"h-jeff-praissman-nbsp-12\">Jeff Praissman&nbsp;<\/h3>\n\n\n\n<p>Great. Thank you, Mat. And for our listeners, if you want to learn more about options education, you can check out our website. You can also visit optionseducation.org. Looking forward to seeing everyone next time.&nbsp;<\/p>\n","protected":false},"excerpt":{"rendered":"<p>Mat Cashman, Principal of Investor Education at the Options Clearing House, joins IBKR\u2019s Jeff Praissman to discuss the Rule of 16 and how traders can use it in their analysis and decision 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