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Volatility in Stock Options
There are two kind of volatility a trader looks for
1. Historical Volatility
2. Implied Volatility
Historical Volatility: It is calculated based on volatility of the stock based on its previous movement. While net movement of the price may be small , its actual movement across mean may be very high on both upside and downside. Standard deviation Beta are used to calculate historical volatility. It provide a good pattern stock has behaved but provides little hint on its future movement. This volatility helps stock investors to buy stocks for long run but has little value for stock options.
Implied Volatility(IV): This is on the other hand tries to predict its future volatility of the stock. It is based on option activity of the stocks. Based on various information and rumors, option price fluctuates up or down independent of its Intrinsic value. IV helps traders predict how market may behave in future and also helps in determine stock price. It is one of the most crucial component in option trading.
As implied volatility increase Option value also increase and if it decrease, then option value also decreases.
Generally Implied volatility is higher in bear market than in bullish market as bearish market is considered as more risky.
There are various factors affecting IV are:
1. Strike price
2. Exercise Price
3. Expiry Date
4. Interest rate
5. Dividend Yield
6. Current Market Price
Implied Volatility(IV) is derived from Black-Scholes Model.
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