The BEST Indicator to tell whether an Option is OVERPRICED is... 1-Implied Volatility 2-Gamma 3-Vega 4-Delta 5-Theta 6-Rho 7-Open Interest 8-Other...? for sake of discussion..lets use the QQQQ...
seeking information...I honestly did not know what options trader look for when pricing and option...meaning saying "nah would not buy at that price as the _____ is too high or low" etc.
"Too low" and "too high" are subjective conclusions based on your own prognosis. IV is the only variable that goes into the option pricing formula that's set by the market. The other variables such as interest rate, dividend, the stock's current price, etc are a priori values. If the stock has a statistical volatility of say 40% and the IV for its options is 50%, one might say that the options are overpriced. But what if you anticipate that the stock's SV is going to increase to 60%? Then it's underpriced, isn't it? BTW, the 50% IV above means the market believes that the stock's SV will increase to 50% in the future. It's the volatility "implied" by the market.
there has to be something that "alerts" you to options becoming way too inflated in price...see it so much...huge interest, price for a call or put option swells and then goes back down and stock did not really do antyhing...I.E around earnings report day...thanks very much for your time and insight...
Yes, but what if there's huge volume, the price for the call swells - and a buyout is announced and the stock jumps 20%? Then it turns out that call wasn't so overpriced after all, was it? The only sure way to know an option is overpriced or underpriced is relative to other options at nearby strikes. If I can buy USO 85's at 40% IV and sell the 86's at 42% IV, then I can say with confidence that the 86's are overpriced. Even then it's not absolutely certain I'll end up with a profit - but I'll take those odds any day. This gets back to delta neutral spreading strategies that are probably more appropriate for futures options than stock options.