Options Volatility by SJ Options
In this excerpt from our live mentoring program, David is talking about options volatility and the pricing model.
All these items, you put them into a pot and we get it—it does all these calculations in the model, we get an option price. Were you guys aware of that? Any questions on that?
These are not calculations that you have to do and whatever broker you have will do that for you but I think it’s important that you know the different items that go into the action pricing model. Think about all these different items. These are all things that we should be familiar with up until implied volatility and all these first items are items that are—they’re known. We know that either an option is a call or a put; we can look at a chart and look at its stock price. We can look at the platform and see what strike it is. We can find out if there’s interest dividend. There’s obviously different months we could look at and we know if they’re American or European. This implied volatility, we actually have to back it out of the model to figure it out because it’s not historical, because we cannot look at a chart and actually see it. What we have to do is take and—we tap to take the option’s price, subtract these first items out and then we’re left with implied volatility.
Just as a quick example, we can do something like this. We know all these items and we know that that equals 14, easy enough. But if we’ve got something like this, with a question mark and we know that it equals 14, then we have to solve for the question mark. We just bring everything over to the other side and say 14 minus what these add up to and so we know that the question mark is three. That’s the same thing we do here to figure out implied volatility but we cannot figure out implied volatility until we have the options price and that’s the options price that has just traded and it’s also the options price that you’re looking at the bid and the ask, the current bid and ask. And you can usually take them and figure it out that way. Again, when I say you can figure it out that way, you don’t actually have to figure it out that way. Your platform will do it for you. I just want to kind of get in your head and let you know that this is how implied volatility is figured out.