Can an OTM option ever be profitable if it never goes ITM?

You are describing the volatility "smirk" that used to be a volatility "smile" pre the '87 crash. This is a deep question that no one really knows the answer to but there are lots of theories. Many think that after the crash of 87, OTM puts are more highly valued than other options.

The IV can be persistenly different from the historical volatility of the underlying.

nitro
 
I've been playing around on an options calculator and so far it appears that for the most part delta hurts an OTM option more than IV helps when an option goes even more OTM.

So I guess most of the time that an IV spike is not enough to counter the loss in value from delta.
 
Quote from union1411:

Follow up question: why do options of the same underlying/same expiration but at different strike prices have different IV?

I thought IV was for underlying - why would it differ based on strike price?
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Never mind my question. I found the answer: demand for an option determines IV. So makes sense it's different for different strikes.
 
Quote from union1411:

Never mind my question. I found the answer: demand for an option determines IV. So makes sense it's different for different strikes.
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The statistical volatility (SV) more than anything else determines the level of IV (since it is a parameter in calculating it.) Anything above the SV priced in is due to IV. This can be due to demand of a particular strike, but it is not necessarily so.

nitro
 
Quote from sundance86:

I thought that SV was a parameter in pricing the option that was replaced by the option price to calculate the option IV?
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Yes, but how do you think the premium over "fair value" (based on SV), or the difference between SV and IV, is calculated?

You have to know fair value first to know what extra premium to give the option by dealers (MMs). In other words, MMs first calculate the BS (or some other derived model) price of what an option should be (based on SV), then add some premium to that (for whatever reasons.)

What IV gives you is the addition that MMs want over "fair price" (SV) for whatever reason.

nitro
 
That I understand, I was clarifying about the actual calculation of IV itself like through bs, which would then give you that comparison to make.

Thanks
 
Wow, I did some research on the web about IV and volatility smiles/skews. I had no idea it was such an involved topic.

[note to self: do research before asking questions on here]
 
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