What is Implied Volatility? – How it affects the Pricing of Options

Implied volatility indicates how volatile a security’s price may be in the future.

It is important to understand that implied volatility is one of the factors that influences the price of options. This article will explain implied volatility so that investors can make intelligent decisions about buying and selling options.

High implied volatility means that the security is expected to have large fluctuations in its price, or that there is uncertainty related to the security. Low implied volatility means that the security is not expected to have large fluctuations in its price, or that there is little uncertainty related to the security.

Options are a contract that give the opportunity to buy or sell a security at a specific price before, or on, a pre-determined expiration date. A buyer pays a premium for the option contract to a seller. This premium is affected by implied volatility.

Higher implied volatility indicates a higher premium for the option. Conversely, a lower implied volatility indicates a lower premium.

It is important to note that implied volatility does not predict which direction the security’s price will go. A high implied volatility indicates a large price swing, but the price could swing high, low, or even both. Alternatively, a low implied volatility indicates that the price won’t make any large, unpredictable swings.

A factor that affects implied volatility is supply and demand. When there is high demand for a security, the price will rise and so will the implied volatility. This leads to a higher premium for the option contract. Conversely, when there is more supply than demand for a security, the price will fall and so will implied volatility. This leads to a lower premium for the option contract.

Another factor that affects implied volatility is the amount of time remaining in an option contract until expiration. A shorter amount of time remaining leads to a lower implied volatility. In contrast, a longer amount of time remaining leads to a higher implied volatility.

Implied volatility is an important concept that contributes to the pricing of options. Understanding how implied volatility affects the price of options is crucial in an investor’s success when buying or selling option contracts.