What have we learnt?
- The implied volatility estimates the future volatility, whereas historical volatility looks backward – don’t mix them!
- Being an essential component of the time value, you need to be aware of the impact of an increasing and decreasing implied volatility;
- If you buy options with high implied volatility, the markets expect more significant price movement, and you pay for that.
- If you think the underlying value will not move as much as the market expects, you can consider selling options.
- As you can see, many elements influence the price of an option. As you have learned, these are the most important ones:
- Underlying value
- Strike price
Standard deviation is a measure of dispersion around a mean value.
- We use underlying forward price and option information to calculate a mean value and standard deviation.
- We can create a probability distribution using the standard deviation and mean value.
- We calculate the area under a probability distribution in a given range to calculate probabilities.
- The standard deviation increases when the volatility increases (all other things being equal).
- When the days to expiration increase, the standard deviation increases (all other things being equal).
- When the standard deviation increases, a strike price is theoretically more likely to expire in the money (all other things being equal).