Learn How to Trade Options (Collection)

29*. Implied Volatility and the Black-Scholes Formula

The concept of implied volatility (IV) is important in evaluating an options trade. Experienced options traders have learned to appreciate that the implied volatility of an option suggests whether the option is overpriced or underpriced. To fully understand the meaning of implied volatility, you need some basic knowledge of the theory of options pricing, as expressed in the famous Black-Scholes formula.

The goal of this chapter is to provide some background and insight into the Black-Scholes formula and how IV is determined from that formula. Also, the use of IV data in trading is briefly discussed.

Historical Background

Back in the early 1970s when options on U.S. stocks were first introduced, ...