Stocks & Commodities V. 33:08 (26–31): Judging Volatility by Chris Lindgren

Stocks & Commodities V. 33:08 (26–31): Judging Volatility by Chris Lindgren
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Judging Volatility by Chris Lindgren

Ignoring implied volatility can be a costly mistake for option traders, which is why assessing it is critical. Here is a look at some practical methods to measure implied volatility and get a better idea of which way option prices will move.

As an option trader, implied volatility (IV) is important to me. All option-pricing models use an estimated volatility to value a security’s options. Implied volatility, however, is derived from current option prices. It is the market’s projection of volatility between now and expiration. The IV tells me the price of an option. Just as a stock trader evaluates price to determine value, I gauge an option’s price with IV. If IV is too high, the options are overpriced; if it’s too low, the options are cheap. The strategy I choose will be determined by my assessment of IV. By itself, any given figure for IV is meaningless. Just as with stock price, IV needs to be evaluated in terms of where it has been and where it may be going. Assessing IV is critical, whether I am placing a delta neutral trade or trading directionally.

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