What is IV?

M

morganpbrown

OK, so I guess I will assume the mantle of "dumb question of the day guy".

Well, maybe not so dumb...

I always thought that IV was a parameter driven by the market that prices options relative to the underlying's volatility. In other words, I expected the IV on a given day to be more or less constant among all options for a given underlying.

Ding dong! Not true!

I did some googling on "volatility smile" and it seems to imply that IV is basically a fudge factor that is adjusted to make the market option price match the Black-Scholes modeled price. :wtf:

So is IV an independent variable or a dependent variable of B-S? Or both? :confused:

How the hell do I model an option's behavior in time if IV is both an input to B-S and dependent on the output of B-S? :banghead:
 
IV...means, basically, Implied volatility.
Around quarterly earnings time...IV is very, relatively, high...because the options volume may indicate something is askew and expected to move.

I personally wouldn't put too much thought or weight behind this...because more often than not...the masses are basically wrong, and dumb, and slightly misjudged the reality of the scenario.
 
For instance...on SPY:

Vary the strike for a given expiration:
Oct 15 446 (ATM) call: IV=12.13%
Oct 15 435 (75d) call: IV=14.54%

Vary the expiration for a given strike:
Sep 20 435 (88d) call: IV=12.05%
Oct 15 435 (75d) call: IV=14.54%
Nov 19 435 (67d) call: IV=16.71%

There's obviously a functional dependence on DTE and strike (and presumably much more) built into this fudge factor. +/- 2% differences in IV are a big deal for pricing!
 
morganpbrown said:
How the hell do I model an option's behavior in time if IV is both an input to B-S and dependent on the output of B-S? :banghead:
More...

It's not an output; with regard to the BSM, the IV is the unique value that must be provided as an input to produce the current option price as an output.

One thing that might be confusing you is that finding the correct IV for a given price is an iterative process (Excel, etc. use a "goal seek" or a successive approximation method.)
 
BlueWaterSailor said:
It's not an output; with regard to the BSM, the IV is the unique value that must be provided as an input to produce the current option price as an output.

One thing that might be confusing you is that finding the correct IV for a given price is an iterative process (Excel, etc. use a "goal seek" or a successive approximation method.)
More...

This is where you people go off the rails. The hell you on about? I speak to you on the phone and it starts to make sense,

Then you start typing shit like this and I am in the dark.
 
morganpbrown said:
There's obviously a functional dependence on DTE and strike (and presumably much more) built into this fudge factor. +/- 2% differences in IV are a big deal for pricing!
More...

I'm not sure what it is you think is being fudged. It's a value of volatility that corresponds to the price; in fact, many professionals don't even use the actual premium but price options in 'vols'. For many practical purposes, the volatility of an option is its price; that's why options trading is often referred to as "trading volatility".
 
Overnight said:
This is where you people go off the rails. The hell you on about? I speak to you on the phone and it starts to make sense,

Then you start typing shit like this and I am in the dark.
More...

I'm multilingual. Math, English, Russian, baby-talk, Pig Latin... all about who I'm talking to. :sneaky:
 
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