What Is the Role of “Volatility” in the Pricing of Financial Derivatives?

Volatility is a measure of the expected fluctuation in the underlying asset's price. It is a key input in derivative pricing models like Black-Scholes.

Higher expected volatility increases the probability that the underlying asset's price will move significantly, thus increasing the chance that an option will expire "in-the-money." Therefore, higher volatility generally leads to higher premiums for both Call and Put options.