Hi guys. I've been broking options for a few months now at a large IDB in the city. I'm technical minded and understand all the different strategies, positions, outcomes etc etc. I know exactly what historical volatility is (annuallised standard deviation of the underlying as a percentage) and know how to work it out in excel. However one thing that i still dont quite understand is what implied volatility is as a number itself. I've asked many of my employees and most of them struggle to explain it and go red. I understand the jist of implied volatility but I think over complicating it. For example say q3-14 on a commodity has a historical volatility of 20%. That's self explanatory. If a call with a strike of 27 has an implied volatility of 26% and the 30 call has an implied volatility of 30% (all of those numbers are completely made up and I understand skew) what does the 26% and the 30% actually mean. The options price for those strikes are suggesting historical volatility is expected to be 26% and 30% in the future if the underlying gets there? Or have I got that wrong? Can somebody simply explain without going to into complex terminology/mathematics? I can work my off the shelf model like my colleagues but I'd actually like to know what the most important number in options means. Thanks.
There was a similar post very recently that you can find some good replies from more knowledgeable ppl: http://www.elitetrader.com/vb/showthread.php?s=&threadid=278294 You need to get rid of that last conditional. Also in general the ATM quote has more "pure" information about future hist vol. It has been said for the BS formula: " the wrong formula that produces the wrong value to get the right price" In this case "the wrong value" is the IV quote which however if you plug into the wrong formula (ie B-S) gives you the right price i.e the market price