How Does Implied Volatility Affect the Price of OTM Options?

Implied volatility (IV) has a significant impact on the price of out-of-the-money (OTM) options. The entire premium of an OTM option is extrinsic value, which is heavily influenced by IV.

Higher IV means the market expects larger price swings, increasing the probability that an OTM option could become profitable before expiration. This increased probability translates into a higher premium.

Therefore, even if an option is far OTM, if the IV is high, it can still be relatively expensive.