IV in Option Premiums, It is Dependent Majorly on 3 Factors, However due to historically high levels of VIX and too much volatility in the market
Implied Volatility IV in Option Premiums
Implied Volatility IV
It is Dependent Majorly on 3 Factors
1.Risk Free Interest Rate Value
These two factors have time value associated with them. Risk Free Interest Value is simple. It is simply the interest that an option seller demands for time frame in which intends to keep his position open. So it would be more for an option that has more days left to expiry.
2.Risk Value
The second factor “Risk Value” is the most important component of an option premium. More the risk an option seller sees more premium he will demand.
3.Demand Value
The third factor takes into account the demand from the buyer and is simply a function of demand and supply. More the demand more is the price.
- More Risk Value that Option seller sees in writing the option
- More demand from buyers
- Very less Risk Value that Option seller sees in writing the option
- No demand from buyers
We see difference in IV on Call and Put side near Max Pain area on option chain. So as a buyer of an option if IV is high there may be a chance that Buyers are inclined more towards that particular side. This has to be validated by OI data that actually represent the true picture.
These days there have been instances where the OI data reflects Bullishness but IV is higher on PUT side. This simply means that PUT writers see very large risk in writing PUT options as VIX is very high and due to high volatility the bullishness may change back to bearishness anytime.
Relatively they see less risk in writing CALL option. Please lay emphasis on relatively word. Also the demand is high from buyers but overall the risk portion is too high for PUT that accounts for higher IV on PUT side despite buyers on CALL side.
This is over simplification bust just a way of understanding.
However in normal circumstances we may not see extraordinary RISK values and greater IV may correspond to greater demand by the buyers only.
COMMENTS