IV explained

No, not intravenous. Implied Volatility, courtesy misc.invest.options.

When pricing options, there are a number of criteria that get plugged into the models:

  • Underlying price (because you see a quote)
  • Strike price (because thats the option you're looking at)
  • Time remaining (because you can look at a calendar)
  • Risk free interest rate (because you can read the papers)
  • Price of the option (because you can see a quote)
  • Volatility in the future (IV) (you have no way of knowing this)

The first five are known values at any given point in time. What is not, and cannot be known, is the future volatility of the underlying. All you can do is look at past volatility (HV). Since anybody with the first five values and a little bit of math can solve for, or imply, what the IV must be to arrive at that particular option price, this is called implied volatility.

Written by Andrew Ittner in misc on Sat 10 April 2004. Tags: business, trading