The Rule of 16 is a simple guideline that some options traders use to determine whether the implied volatility of an options contract is high or low. The rule states that you should take the options price and multiply it by the square root of the number of days until expiration. If the result is greater than 16, the implied volatility is considered high, and if the result is less than 16, the implied volatility is considered low.
For example, let’s say that you are looking at a call option that is currently trading for $2.50 and expires in 30 days. Using the Rule of 16, you would calculate:
$2.50 x sqrt(30) = $12.89
Since $12.89 is less than 16, the implied volatility of this option is considered low.
The Rule of 16 can be a useful tool for options traders to quickly assess whether an options contract is overpriced or underpriced relative to its implied volatility. However, it’s important to note that the rule is not foolproof and should be used in conjunction with other analysis techniques.