Implied Volatility IV

[rapidex]

Implied volatility seems key to trading options.

As I understand it IV, is as it sounds, the implied volatility of an option and it either increases or decreases the price of said option. IV is equated into the option premium.

So my question is: What determines IV for any given option. Where does the IV comes from? Does it have to do with the volume of an option, or demand for an option at any one time?. Or perhaps there is a formulae for calculation the IV of any option?

 

[wayneL]

Re: Implied Volatility IV ...

Implied volatility seems key to trading options.

As I understand it IV, is as it sounds, the implied volatility of an option and it either increases or decreases the price of said option. IV is equated into the option premium.

So my question is: What determines IV for any given option. Where does the IV comes from? Does it have to do with the volume of an option, or demand for an option at any one time?. Or perhaps there is a formulae for calculation the IV of any option?

Here's Wikipedias definition.

Here's mine:

You can determine the theoretical price of an option using the Black Scholes Option Pricing Model (and as proxy for other models). The inputs to the equation are:

1/Stock Price
2/Strike Price
3/Time till expiry
4/Dividend
5/Risk free interest rate
6/Volatility

This will give you a theoretical price for the option.

What messes up the above scenario is that volatility going forward is unknown and must be guessed at. So on the open market we are left with price discovery of the option via the bid/ask in the market at any one time.

Implied volatility is an output of BSOPM. We know inputs 1/ to 5/ above. We know the current price of the option. So using algebra, we can work out the Implied volatility from the knowns.

Cheers

 

[rapidex]

Thanks WayneL - still getting my head around it, but makes things clearer.