How Does Implied Volatility Affect the Premium of an Option?
Implied volatility (IV) is a measure of the market's expectation of future price swings in the underlying asset. It is a key input in option pricing models, such as Black-Scholes.
A higher implied volatility indicates that the market anticipates larger price movements, increasing the probability that the option will finish in-the-money. Therefore, a rise in implied volatility directly leads to a higher option premium, all else being equal.
Glossar
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.
Historical Volatility
Evidence ⎊ This metric is derived from the time-series of past asset prices, representing the actual realized dispersion of returns over a defined historical window.
Volatility Smile
Curve ⎊ The volatility smile, observed in options markets, represents the graphical depiction of implied volatility across different strike prices for options with the same expiration date.
Price Swings
Volatility ⎊ Price swings, within cryptocurrency markets, options trading, and financial derivatives, represent abrupt and substantial fluctuations in asset prices.
Vega
Sensitivity ⎊ Vega, within the context of cryptocurrency options and financial derivatives, quantifies the rate of change in an option’s price with respect to changes in the underlying asset’s implied volatility.
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.