By doing his best to estimate the future volatility of the stock. But implied volatility is a different thing -- it's whatever you have to plug into Black Scholes (or it's Americanized equivalent) to get the known price. If you don't already have a known price you do not have a known implied volatility, so obviously you can't price an option based on its implied volatility.
Right, so you agree that volatility comes first? Further, it's pretty easy to prove to yourself that implied volatility is nothing more then markets guess of the future realized vol. The fact that this volatility "estimate" comes from a price of an option or is quoted to you directly (as in case of variance swaps) or estimated by taking volatility of a related instrument is not important. What is important is that option is priced in a risk-neutral setting (yes, it is true) and it's price depends on the expectation of volatility rather then expected returns of the underlying or any other sort of woodoo.
+1. the asymmetric return is not to be understated. if you're trading cl and there's an incidient w/ iran/saudi arabia/etc and oil goes up 50% or 100% overnight (yes this could happen) even trading w/ low leverage you are wiped out but if you were long puts you only lost your premium. an alternative is to trade the futures but long otm calls in the case of commodities to hedge black swan risk.
+100 Leverage isn't the point... The embedded liquidity option is (no good way to price it, but it's valuable) and so is vol & correlation. You shouldn't get involved in options unless you're interested in either of the two. It's interesting that someone who has supposedly been trading options for 20 years hasn't grasped it.
Yeah. When you trade an option you are taking a view on volatility explicitly or implicitly. Explicitly if you are trading vol as an asset; implicitly if you think the option is a better trade than the underlying equivalent.
"Quote from StarDust9182: My comment to SLE was only the first one and that was intended to save him from harm. In that case, could you please clarify what exact harm is going to come to me if I look at options from vol traders perspective? BTW, those who do not believe that vol comes before price, ask yourself - "how would a sell-side trader price an option on a stock that has no liquid option market?"" I was unsure of what level to address my reply until I had read more of SLE had written. I have read enough in this thread to make my decision. Sorry for the delay. SLE, I agree that you will be in no trouble because you have a very high level of understanding of options. I hereby withdraw my concern for your trading welfare. I am not interested in arguing who is right or how many angels fit on the head of pin. I am interested in making money consistently. For most people reading the above comment, my concern is that if you try to pick options using implied volatility graphs, then in my view you are doomed to failure since implied volatility is price. Implied means derived and derived is from the particular price model you use of option reality. The problem is similar to using indicators to try and forecast future price when the indicators are derived from price ultimately. Semantically, when two words refer to the same concept then in my view, it is impossible for one to come before the other. Wikipedia has a link on implied volatility. Hopefully the first sentences explain better what I am saying.
I should add that in all my previous posts in this thread, I am talking from the point of view of speculation and not as a hedger or market maker would see things. I thought that is what the op was asking.