Option Volatility Volatility is an essential element determining the level of option prices. It is a measure of the rate and magnitude of the change of prices (up or down) of the underlying. If volatility is high, the premium on the option will be relatively high, and vice versa. Once you have a measure of statistical volatility (SV) for any underlying, you can plug the value into a standard options pricing model and calculate the fair market value of an option. Actually volatility are two types historical volatility and implied volatility which is used to determine whether options are expensive (means they trading at prices high relative to spast levels) or cheap.

Importance of Option Volatility Impact of volatility changes on option trades is good as well as bad. In addition to this so-called Vega risk/reward, in this all parts of the tutorial we'll provide key insights and practical tips about how to use the concepts mentioned above as they relate to volatility and Vega. Virtually volatility of option can be used for the following rationales.

Valuation of Options: The most practical aspect of a volatility perspective on options strategies and option prices is the opportunity it affords you to determine relative valuation of options. Due to the nature of markets, options may often price in events that are expected. Therefore, when looking at option prices and considering certain strategies, knowing whether options are "expensive" or "cheap" can provide very useful information about whether you should be selling options or buying them.

Selection of Strategies: Another important use of volatility analysis is in the selection of strategies. Every option strategy has an associated Greek value known as Vega, or position Vega. Therefore, as implied volatility levels change, there will be an impact on the strategy performance. Positive Vega strategies (like long puts, backspreads and long strangles/straddles) do best when implied volatility levels rise. Negative Vega strategies (like short options, ratio spreads and short strangles/ straddles) do best when implied volatility is falling. Clearly, knowing where implied volatility levels are and where they are likely to go once in a trade can make all the difference in the outcome of strategy.

Predictor of Price: Finally, Implied volatility is also used as a predictor of the future direction of stocks and stock indexes. Actually Implied volatility can be used as a predictor of price from two angles: as a contrarian, when implied volatility has moved too far - high or low - or as a sign of potentially explosive price moves when implied volatility is extremely high for no apparent reason. Typically, the latter occurs when there is a pending unknown or even known event but it is not clear which way the stock will move. All that the extremely high implied volatility tells you is that something big is in the offing.

Conclusion: Volatility is a measure of how rapid price changes have been statistical volatility (SV) and what the market expects the price to do implied volatility (IV). When volatility is high, buyers of options should be wary of straight options buying, and they should be looking instead to sell options. Low volatility, on the other hand, which generally occurs in quiet Indian stock markets, will offer better prices for buyers; however, there's no guarantee the market will make a violent move anytime soon. By incorporating into trading an awareness of IV and SV, which are important dimensions of pricing, you can gain a decisive edge as an options trader.

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