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Implied Volatility formed one of the significant component of an option's premium ie. the price of an option.
Implied Volatility (IV) is simply a measure of the current level
of risky-ness of a stock option. It is sometimes compared with its historical volatility (HV) to determine whether
this level has risen or
has been down lately. Naturally, when IV is high, an option premium is higher
(since it has a higher probability of going into-the-money) and when IV is lower, the option premium is cheaper.
But IV is only part of the option premium component, the option's
premium can still be affected by other components like share price, strike price, time
until option expiration, interest rate, dividend yield.
If you have information of the option's premium & these components just
mentioned, you can use Black-Scholes Model
options calculator to calculate an option's implied volatility.
If you have an online options trading account, you can always check any
option's implied volatility & historical volatility from the option's price chain. Check with your online broker
on how to locate this information if you can't find them. You could open
an online options trading account HERE.
So what would cause the implied volatility of an option to increase?
Usually it's due to an anticipated event which is going to affect the stock price
very significantly in the near future. This event could be an upcoming earnings or guidance
announcement, a potential takeover bid, upcoming FDA results for
a company's drug submission etc.
The implied volatility of the stock option, whether it's a put or
call, would gradually increase as the significant event draw nearer.
You might be puzzled why you have bought a call option on the eve of an event announcement, the outcome turned out to be positive and the share
price subsequently moved up a few points but your call option still lose money. This was because usually after an event has
occurred, the option's implied volatility would return to its normal value after reaching an extreme (known as mean reverting)
and the option premium would drop dramatically due to this reduction
in
implied volatility. The only way for this option position to be
profitable
would be if the stock price made a substantial price movement in your
anticipated direction and the stock option you've
bought gained plenty of intrinsic value. Don't forget that your
option premium would also have time value if there's still some time
before expiration.
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