How Does Implied Volatility (IV) Affect the Time Value of an Option?
Implied Volatility (IV) is the market's expectation of future price fluctuation. Higher IV increases the probability of the option becoming In-The-Money before expiration.
Since time value represents this probability, high IV directly increases the time value (extrinsic value) of the option. Low IV reduces the time value.
Glossar
IV Spike
Volatility ⎊ An IV spike denotes a rapid and significant increase in implied volatility, which represents the market's expectation of future price fluctuations for an underlying asset.
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.
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.
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.