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Trading Weekly Options + Online Video Course: Pricing Characteristics and Short-Term Trading Strategies by Russell Rhoads

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CHAPTER 6

Implied Volatility and Weekly Options

Implied volatility is often described as a risk factor that is associated with the market price of an option. However, it is not exactly a measure of risk in the sense that most traders think of risk. When traders or investors think of risk they generally are contemplating the potential for loss in an investment. As a measure of risk implied volatility can be used to estimate how much downside price action the option market is pricing in for a certain stock or market. However, implied volatility may also be used to determine how much of a potential price rise is being priced in by the option market as well. Implied volatility is an indication of what sort of price movement—higher or lower—is being anticipated out of the underlying market over the life of an option contract. Higher implied volatility is an indication that there is more price action in both directions expected out of the underlying market.

Time to Expiration and Implied Volatility

There is a direct relationship between option premiums and implied volatility. When implied volatility moves up the result is higher option premiums and when there is lower implied volatility priced into an option contract option premiums are lower. An option price change that is attributed to changes in implied volatility will only have an impact on the time value of an option contract. Since volatility-based price changes only impact the time-value component of an option contract, when ...

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