How does a beginning options trader use implied volatility? And why do advanced options traders quote options in terms of their implied volatility? Thanks!!!
And what could cause a IV crash? And what about my second question? Any one else here to help us out?
The volatility usually runs up ahead of some event, such as earnings announcement or an FDA ruling. Then after the info is out the volatility gets crushed. The reason options are quoted/talked about in terms of volatility is because it is the only unknown in the option pricing model, all the other factors are easily observable or fixed.
It shows you what sort of move the market prices in. For example, which one is more informative: (i) an Apr ATM call is trading at 7.05, or (ii) at 46% implied volatility!? With the second one I can immediately estimate what sort of move the market prices in, without knowing anything else, as oppose to the first one, which doesn't tell me anything. Otherwise, I suggest you read a book or two on options, such as "Option volatility & pricing", among other books.
I think that the trend of the VIX is just as important as the absolute value. If the VIX is in a sideways range, you will see tremendous price fluctuation--which is why it is considered a trader's market. If you simply sell a naked put in this environment, you can be easily taken out with a downward swing. Try hedging with a short future, and you will be in and out of your hedges all the time, and this eats up your profits. We are in a sideways, high volatility trend now. Once volatility begins to trend downward (gets below 20), then selling short puts with a hedge will be tolerable and profitable. Low, sideways volatility can be managed in several ways. The change from low volatility to high volatility lends itself to bearish techniques--like watching the change in the market character from the end of July 2007 to the present.
So, let's say I've got a XYZ 50 call expiring 365 days from now, and XYZ is currently trading at $49.50. XYZ pays no dividends. The risk-free rate is 4.382%. The call is trading at $7.50. What would the volatility be, and what could affect it? Things like quarterly earnings, news announcements, etc.? How should I best use this info?
but if the stock has been very volatile to begin with say within the last 2 months, then the 46% IV would just be business as usual wouldnt it? Isnt it more useful to show the ratio between the current IV vs the historical volatility instead? Is there such thing as historical volatility on the individual strike price bid/ask? thanks
Read my posts in <a href="http://www.elitetrader.com/vb/showthread.php?s=&postid=1865485#post1865485">this thread</a> ...especially the last 3 posts I explain implied volatility, Vega, how it affects option prices, show a chart and provide a resource to obtain your own volatility charts.