Volatility is a measure of how quickly (the speed) the stock (but can be any security) moves up or down in price. Statistically, it is usually calculated as the standard deviation of stock prices over some time, usually annualized. This statistical measure is expressed as a percent. A stock that has a 90% volatility is more volatile than a stock with 20% volatility. Since implied volatility is a projection, it may deviate from actual future volatility. This is the only variable that is truly unknown (“implied”), it can be substantially out of line with what one might reasonably expect should happen, because of that, traders can use their analysis to exploit it to their advantage.
If implied volatility is relatively high, options will be more “expensive”. On the other hand, if implied volatility is relatively low, options will be more “cheap”.
The terms “expensive” and “cheap” are not correct, because it is a relative term and the price of today that looks “expensive” can tomorrow be more expensive.
We can see this example on the chart. Two stocks that are relatively close in price. ZM implied volatility for the option presented is 77.4% NVDA implied volatility for the option presented is 51.2%
Traders need to check the implied volatility of the stock to itself and other stocks, depending of course on the strategies they want to use.
The vega
Vega is the amount by which the option price changes when the volatility changes. Volatile stocks have more “expensive” options, meaning the price of the option will raise if the volatility will increase and will fall if the volatility will decrease. The vega is an attempt to quantify how much the option price will increase or decrease as the volatility moves, all other factors being equal.
Vega is expressed as a positive number. (when buying options)
For example, if the stock XYZ is at 100, and the 110 Call is selling for 12. The vega of the option could be 1.5, and the current volatility of XYZ is 60%. If the volatility increases by 1% to 61%, then the vega indicates that the option will increase in value by 1.5, to 13.5. If the volatility decreased by 1% to 59%, then the call would have decreased to 10.5.
Vega is related to time. The more time the option has remains, the higher the vega is.
Vega is greatest for At the money options and approaches zero as the option is deeply In the money. Since a deep In the money option will not be affected much by a change in volatility, it will be most affected by the stock price. Also, for at-the-money options, longer-term options have a higher vega than short-term options.
Vega does not directly correlate with other “greeks” like delta or gamma.
Chart explanation:
Lines: Blue 3 points, light green 2 points, dark green 1 point, yellow break-even, red -0.95 points (95% loss).
Strong colored lines – The option inputs at Friday close Weaker colored lines – Increasing only the implied volatility by 30% The meaning of this is to show what will happen if after we entered the trade the volatility will change. (Increase in this case)
I want to note, that the absolute increase is 30%, but the relative increase is different, meaning the 30% increase has more effect on NVDA, because it has a lower IV, 48.5% to 78.5% the increase here is 61%, ZM higher IV 77.4% to 107.7% the increase here is 38%.
This means that you will profit much faster in NVDA if the IV will go up 30%.
In the next educational post, I will write about option strategies, specifically about Strangle VS Iron Condor.
Comment
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Here you can see what will happen to your profit if the implied volatility will decrease by 30%.
super helpful. I'm new to trading and I've been trying to view option price charts similar to stock prices but don't seem to find it anywhere. Is that by design?
I'm trying to view the historical trends of option prices for a given stock and call/put date. Is there a place where i can find it?
ZoharCho
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@chantush, I know that there is a possibility to see historical options prices on my broker platform, and only on options that are currently trading (not options that were expired).
I hope it answered your question.
@ZoharCho, I see. Which platform is this? I don't seem to find any source out there that gives historical trends but only of those options after you start trading them.
ZoharCho
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@chantush, Interactive brokers, I am not sure what you mean by trends. You can see what is the price of the option (that is live - not expired) since the date you could have started trading it.
Tom1trader
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@Prats91, CBOE and others (per GOOGLE search) has historical option prices.
I'm trying to view the historical trends of option prices for a given stock and call/put date. Is there a place where i can find it?