OPTIONS

Sunday, August 3, 2008

The Impact of IMPLIED VOLATILITY (IV) on OPTIONS GREEKS: Summary

The Impact of Implied Volatility (IV) on DELTA
Assuming all other factors constant, when Implied Volatility increases, the time value portion of an option will increase.
As a result, the delta of OTM (Out-of-The-Money) options will go up, whereas the delta of ITM (In-The-Money) options will go down.
Nevertheless, the delta of ATM (At-The-Money) options will always remain at around 0.5.

Why is it so?
As discussed previously, IV has a very big impact on the option price. However, IV would affect only the time value component of an option's price, not on the Intrinsic Value.
Therefore, when there is significant movement in Implied Volatility, ATM and OTM options will be greatly affected as compared to ITM options.

However, although ATM will be significantly affected by IV movement, the delta of ATM options will always be around 0.5.

The Effect of Implied Volatility (IV) on THETA
When Implied Volatility (IV) decreases, Theta will be lower, especially when it is approaching expiration.
On the other hand, when IV increases, Theta would be higher.

Why is it so?
As discussed earlier in this post, Time Value as the price that people are willing to pay for the chance / uncertainty as to whether or not an option will finish ITM.
The more uncertain, the higher the time value will be.
An option that is far OTM has almost no chance of finishing ITM. As such, it will not command a high time value.
An option that is already deep ITM is almost certain that it will finish ITM, hence time value is smaller.
But ATM or near ATM options have more uncertainty as to whether or not the options will finish ITM, and therefore these options have a higher time value.

When IV decreases, such uncertainty will be lower, particularly when the option is nearing to expiration. This lower uncertainty will then be reflected in lower time value. Since Theta is the decrease of time value due to the passage of time, Theta will naturally be lower because it has less time value to lose over the remaining time to expiration.

For more detailed discussion, go to: Options Greek.

Related Topics:
* Options Trading Basic – Part 1
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Understanding Candlestick Charts
* Learning Charts Patterns
* Trading Videos from Trading Experts You Should Not Miss

8 comments:

Tony Chai said...

Hi OTB :

As usual. Great knowledge to remind options traders about the impact of IV on options premium.

Tony Chai

Anonymous said...

hi OTB,

Do you have any idea where can we get historical option prices with implied volatility too?

Thanks

regards
Option beginner

Anonymous said...

Thanks for the information. I've never been a big fan of the greeks but your post did help.

OPTIONS TRADING BEGINNER said...

Hi Tony,

Thanks.
Glad to see your comment again. :)

Regards,
OTB

OPTIONS TRADING BEGINNER said...

Hi Anon,

For historical option prices, we can get from OptionsXpress, if you open an account with them.
You can also plot a chart for option prices.

For IV data, pls refer to this post:
How To Get Historical Volatility (HV) vs. Implied Volatility (IV) Information

Regards,
OTB

OPTIONS TRADING BEGINNER said...

Hi PW,

My pleasure. :)
Glad if you find it helpful.

Regards,
OTB

Stock Trading School said...

Do you currently use options charting as part of your strategy?

OPTIONS TRADING BEGINNER said...

Hi Smftrader,

Sorry, I'm not very sure which one that you refered to as "options charting".