Secret 57IMPLIED VOLATILITY—AN OPTION ANALYSIS SHORTCUT
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Implied volatility is the volatility built into the option price.
It is what the market thinks the volatility should be.
A computer program can measure the implied volatility by
using the present option price and the pricing model, testing and
retesting until the statistical volatility generates the present option
price. That volatility, then, is the implied volatility; the implied
volatility will usually come close to matching the historical
volatility, suggesting the option is fairly valued.
The implied volatility is another way to determine if an option
is over or underpriced. Look at a chart of the implied volatility
for a stock or futures. (Check the IBM chart.) When the
implied volatility is extremely low, based on its past history, the
underlying option is underpriced. When the implied volatility is
extremely high, based on its past history, the underlying option is
overpriced.
The same procedure can be followed by looking at a chart of
the historical volatility over the past months or years. Also, implied
volatility can be used when calculating a probability of
profit or or when using a simulator.
Implied volatility is the volatility built into the option price.
It is what the market thinks the volatility should be.
A computer program can measure the implied volatility by
using the present option price and the pricing model, testing and
retesting until the statistical volatility generates the present option
price. That volatility, then, is the implied volatility; the implied
volatility will usually come close to matching the historical
volatility, suggesting the option is fairly valued.
The implied volatility is another way to determine if an option
is over or underpriced. Look at a chart of the implied volatility
for a stock or futures. (Check the IBM chart.) When the
implied volatility is extremely low, based on its past history, the
underlying option is underpriced. When the implied volatility is
extremely high, based on its past history, the underlying option is
overpriced.
The same procedure can be followed by looking at a chart of
the historical volatility over the past months or years. Also, implied
volatility can be used when calculating a probability of
profit or or when using a simulator.