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The Effect of IV on Option’s Buyer and Seller
As higher IV causes option price to rise (assuming other
things constant), an increase in IV would benefit option buyers, but
will be disadvantageous for option sellers (for both Calls & Puts).
On the other hand, a decrease in IV would have a negative impact on
option buyers, but will be beneficial for option sellers.
As a result:
When IV is relatively low and is expected to rise, buy
options (i.e. consider options strategies to take advantage
of the expected move that allow us to be an option buyer).
When IV is relatively high and is expected to drop, sell
options (i.e. consider options strategies to take advantage
of the expected move that allow us to be an option seller).
Implied Volatility (IV) For Various Strike Prices
IV is generally not the same for various strike prices, and
also between Call & Put options.
For the same expiration month, IVs vary by strike prices.
For some options, the IV of ITM & OTM options are higher ATM options.
Hence, when the IVs for various strike prices are plotted into a
chart, it would take shape approximately like a U-pattern, which is
by glance, it looks like a smile. As such, this is often known as “Volatility
Smile”.
Other options may have higher IV for more OTM options, and then it’s
decreasing as it moves towards ITM. Such pattern is called “Volatility
Skew”.
Basically, either Volatility Smile or Volatility Skew is typically
used to describe the general phenomena that IVs vary by strike price.
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