What Is ‘Volatility’ and Why Is It a Key Factor in Option Pricing?

Volatility is a measure of the degree of variation of a trading price series over time. It reflects the rate and magnitude of price movements.

It is a key factor in option pricing because a higher volatility increases the probability that the underlying asset's price will move far enough to make the option profitable. Therefore, higher volatility generally leads to higher option premiums, reflecting the increased chance of a large payoff.