How Does Implied Volatility Impact the Time Value Component of an Option?
Implied volatility (IV) is a major component of an option's time (extrinsic) value. Higher IV suggests that the market expects larger price swings in the underlying asset.
This increased uncertainty and potential for profit lead to a higher option premium, thus increasing the time value. While Theta measures the decay of time, higher IV effectively inflates the total amount of time value available to decay.
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.
Implied Volatility Impact
Pricing ⎊ Implied volatility impact refers to the influence of market expectations regarding future price fluctuations on the premium of an options contract.
Time Value
Component ⎊ Time value, also known as extrinsic value, is a component of an option's premium that reflects the probability of the underlying asset's price moving favorably before the option expires.