Implied volatility (commonly notated as “IV”) has a positive and direct relationship to the price of options in general and thus dictates many decisions a trader will make regarding options. So what is it all about and what’s the easiest way to understand it? We break it down into three key concepts.
The first key concept was explained. An example comparing two options with different prices was displayed. The example compared the options price, time to expiration and its IV. The concept showed that the IV represents the price of the underlying’s options relative to the amount of time until they expire. The higher the IV, the higher the price will be (with the same amount of time until expiration).
The second key concept was introduced. A table was displayed comparing the expected 1 year range of a $100 stock with a 10%, 20% and 50% IV. The concept showed that IV is expressed as an annualized percentage and represents the expected range for an underlying over the next year.
The third key concept was examined. Riskier stocks will have higher IV and higher option prices. You can think of an underlying’s IV as its level of future risk:
The Skinny On Options Math: “Implied Volatility & Option Pricing” from April 16th, 2015
Options Jive: “Implied Volatility Relationship” from May 15th, 2015
The Skinny On Options Data Science: “Implied vs Actual Volatility” from May 13th 2015
Options Jive: “The Benefits of Higher Implied Volatility” from February 17th, 2016
Watch this segment of “Options Jive” with Tom Sosnoff and Tony Battista for the summary of the three key concepts of IV.
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