More specifically, option pricing, but volatility creates an agreed upon range be it historical or implied. FS
FS: IMHO: Option prices are determined from supply and demand, not IV (IV is result of price) It may seem the "Tail is Wagging the Dog" at times. Do you have some specific example, which resulted in your question?
Yeah, IV is derived from the price that MM set.. but they use IV to set the price... The options prices and IV's are basically the same. And they are 'determined' by supply and demand and that relies on the expected vols based on historical vols. Historical Vol can be high, but the event has passed so IV can be low. And vice versa, Historical Vol can be low, but an event coming up means IV is higher....
A stock is trading in a $20 - $21 range. Buy $20, and sell a $21 call. Call premium = Stop loss. If the market is rising, how does the rate at which the call is losing value compare to the present directional profit being earned? Can a profit be squeezed while paying for the risk with insurance?
What do you mean by this? Rate of call value change depends on the delta of the call, which depends on time to expiration and IV. And the delta will change with gamma, which also depends on time to expiry and IV. What's your expiry date and what IV is involved?
Option greeks are formula driven based on arbitrary IV (implied, MM guess). If options were based on HV (facts) alone, it would be so much easier to show a profit. IMO.
You can't base options on HV alone, because that's past data and options are about future possibilities. IV is basically a guess/analysis for future vol based on the past and future events. A past fact alone doesn't say anything about the future.
If you try to figure the why of Options premiums you will lose your mind. Just know that if you're trying to speculate and make money with Options it's not going to happen.
I agree with the first part, understanding the technicalities of an option trade is not that important...you should instead focus your efforts on the tactical and strategical planning of the underlying. The second part sounds very close-minded. The word Speculate usually has negativities associated with it. I believe there are varying degrees of speculation/gambling...try to make it less ambiguous.
We may be getting slightly off target, but to follow up on some of the IV derivation: The IV derivation varies with the sophistication of the trader. The Greeks are computed based on the IV assumption/derivation. So, to some traders, the derivation of the IV is very critical to their trading (to most, the broker supplied IV is close enough). TOS allows selection of 3 methods to derive their IV. However, it has been observed that the selection you make is sometimes ignored (Vol Smile may or may not be used). Some tool providers, such as OptionVue go to varying lengths to attempt to provide more accurate IV data by observing many options, and for some, the changes over time. Sometimes they screw this up (and hopefully then correct their algorithms). For some traders who have been burned by improper IV derivations (resulting in their Greeks being off), rely on computing their IV themselves so they KNOW what they are using. FYI: If the IV for a particular option contract is reported as 15%, when in fact it is actually 17%, this can be critical to specific trading strategies, hence my book above. -- IF you are very short term trading simple strategies, this may be of no importance or impact.