Explain the Concept of “Implied Volatility” in Option Pricing.
Implied Volatility (IV) is a forward-looking metric derived from the current market price (premium) of an option contract. It represents the market's collective expectation of how much the underlying asset's price will fluctuate between now and the option's expiration.
IV is a critical input in option pricing models; a higher IV results in a higher option premium because the increased expected movement raises the probability of the option expiring in-the-money.
Glossar
Implied Volatility
Expectation ⎊ This value represents the market's consensus forecast of future asset price fluctuation, derived by reversing option pricing models using current market premiums.
Option Pricing
Derivatives ⎊ Option pricing is the mathematical process of determining the fair theoretical value of a derivative contract, such as a call or put, based on inputs like the underlying asset price, time to expiration, volatility, and prevailing interest rates.
Volatility
Measurement ⎊ Volatility, in quantitative finance, is the statistical measurement of the dispersion of returns for a given financial asset, typically quantified by the annualized standard deviation of its price movements.
Bullish Markets
Momentum ⎊ A bullish market denotes a period of sustained upward price trajectory for underlying digital assets and their derivative instruments.
Bearish Markets
Trend ⎊ A market condition characterized by sustained downward price movement across digital assets and their associated derivatives.
Option Premium
Cost ⎊ The Option Premium represents the initial cost paid by the buyer to acquire the right conveyed by the contract, functioning as the price for risk transfer.