In a scenario like this, the IV might be relatively high for options with a strike price of $1.05B, and lower for options with a strike price of $950M. This could indicate that it would be hard for the company to ever drop below $1B in value, because the company has the option to sell its land for $1B and liquidate funds to its shareholders. Based on the current revenues earned by its rents, assume the market values the company at $1.1B. As an example, assume a real estate company owns land that it could immediately sell for $1B. (b) the change in strike price is enough to fairly imply that the bigger change is far less likely to occur. (a) one of those options was most recently traded for a bad price OR So what does it mean if one option has IV of 17% and the next one has IV of 26%? Basically, it means that either: This often occurs because liquidity on those options is incredibly low, so there is a bigger spread between what a buyer is willing to pay, and what a seller is trying to demand. If you look at the pricing on an options chain, you will typically see IV's quite close to eachother, implying that buyers and sellers of all those options generally agree on the likely volatility, until you get far out of the money, when there is likely to be a gap / jump in IV. So why is IV listed as if it is an indisputable fact on an options chain? Because it creates something closer to an 'apples to apples' comparison of the price of one strike price vs the next. If someone overpays for an option, it will drive the calculated IV upward, basically saying "The last person who bought this option thinks the stock is incredibly volatile". It is not some analyst's opinion of how the stock is doing, it is purely a mathematical function using the Black Scholes model, given all current factors (strike price, option price, time to expiry, and the current stock price). The actual IV listed for a stock option is a reflection of its most recently traded price. Another way to say this same fact: "Since this option was last traded for a tiny price, the buyer and seller of that trade are each implying that the volatility of the stock is low". Mathematically, this is shown as a low IV. Another way to say this same fact: " Because the price for this option is tiny, we can assume that 'the market' thinks it is very unlikely to end up in-the-money". So, we should expect that the price for this option should be tiny. For such a stock, buying a put option expiring this month with a $90 strike price is almost worthless - because there is barely any chance that the stock's price drops 10% in the next few weeks. Implied Volatility is, basically, a signal what an option's price means, in terms of the market's opinion of the likely magnitude of future price changes that would reach a given strike price.Īssume a rock-steady stock trades at $100, that most people expect will continue at the same price forever. If each stock has options with literally all types of strikes (and IV's) with the same expiry, then what conclusion can we draw based on that? It is always true that many people think many things.If each strike has an IV, and IV depends on the strike price, then what is the general IV of an option with an expiry at x?.The right red mark shows some sort of generic IV which is not clear how all platforms calculate (can't be BSM because it requires a strike and this one is generic IV). The left red mark shows that each strike has a different IV. But what does 17% volatility for a certain strike mean? 17% of what? I can't find a direct explanation of what this number means, instead I can read many theories on how we calculate it and why it is different. I know that this volatility is an output from the Black Scholes Model, but if one strike has 17% volatility, and another has 26% (skew), then what does it mean about the stock?ĭoes it mean the stock can move 17% within 1SD? Or does it mean 26%? If not, why then does delta matter? (Delta is a product of IV). Now, if you look at the chain of options with the same expiry, each strike price of the same option has a different implied volatility next to it on any platform. I know that 20% implied volatility means 1 standard deviation probability that the underlying asset will move 20% from the current price. After spending 2 days researching I realized not many people know how to answer this, and most answers going around and not direct.
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