A lot has been said about volatility and its effect on the options pricing, maybe it’s time for me to give you a more practical illustration so that you can get the massage embed into your head and not to pay for overpriced options anymore.


Vega is a Greek term used for the rate of change between an option’s premiums in relation to the stock’s volatility. It means that as the volatility increase the options premium will increase accordingly.


Measurements of the fluctuation of the stock in the market price also know as a measurement of risk. Historical Volatility is a measure of actual asset price changes over a specific period of time. Implied Volatility is a measure of how much the market expects asset price to move.

High Volatility = High Risk = High Options Premiums


Here is a comparison of AIG options both with 60 days expirations offered at different point in time.

aig0707.jpg

On 25 May 07, AIG 60 days July 07 expiration options premium are relatively cheap. $0.35 for nearest OTM Call and $0.55 for nearest OTM Put.

 

aig1107.jpg

On 16 Sept 07, even though AIG stock price has fallen but the AIG 60 days Nov 07 expiration options premium has become very much more expensive. Nearest OTM Call is now $3.40 and nearest OTM Put is $1.40.

Notice the big difference in the option premium. This is mainly due to the change in the Implied Volatility.

“The advance trader will always use volatility to their advantage to maximize their profits and not to pay for overpriced options”

Popularity: 75% [?]

Don't want to miss a thing? Subscribe to my RSS feed!




You Should Also Check Out This Post:

More Active Posts: