How Does the Concept of ‘Implied Volatility’ Affect the Pricing of Options?
Implied Volatility (IV) is a measure of the market's expectation of future price swings in the underlying asset. It is the key input in the Black-Scholes or similar option pricing models.
Higher IV means the market expects larger price movements, making the option more likely to end up in-the-money, thus increasing the option's premium (extrinsic value). Conversely, lower IV leads to a lower premium.
IV is derived from the current market price of the option, unlike historical volatility, which is calculated from past price data.
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.
Future Price Swings
Price Projection ⎊ Future Price Swings refer to the anticipated magnitude and direction of movement in the underlying cryptocurrency price over a defined period, which is the primary variable that options strategies seek to forecast or monetize.
Volatility Surface
Calibration ⎊ The volatility surface, within cryptocurrency options, represents a three-dimensional depiction of implied volatility indexed by strike price and expiration date; its calibration involves determining the parameters of a stochastic volatility model to best fit observed market prices of options contracts, a process crucial for accurate derivative pricing and risk assessment.
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.