Why Is IV a Key Input for the Black-Scholes Model?
Implied Volatility (IV) is a key input because the Black-Scholes model requires a measure of the underlying asset's price fluctuation to estimate the option's fair theoretical value. Since all other variables (underlying price, strike, time, interest rate, dividend yield) are known, IV is the only unknown parameter that must be estimated or derived.
It fundamentally determines the time value component of the option price.
Glossar
Time Value Component
Decay ⎊ The Time Value Component, within cryptocurrency options and financial derivatives, represents the diminishing intrinsic value of an option as its expiration date approaches, reflecting the decreasing probability of the underlying asset reaching a favorable price.
The Black-Scholes Model
Foundation ⎊ The Black-Scholes model serves as the cornerstone for modern options pricing theory, providing a continuous-time framework for calculating the fair value of derivatives.