CHAPTER 6Implied Volatility and Term Structure

I introduced the concept of implied volatility, images, in Chapter 1. The objective in this chapter is to deepen our understanding of this fundamental quantity's use in practical options trading. There are two main ideas to understand.

The first is the definition of images. Rebonato (2004) famously and appropriately described images as “the one number to put in the wrong formula to get the right price of plain‐vanilla options.” I explain what he means by this and why, despite this description, images remains the most commonly used metric in practical trading.

The second relates to the fact that images is typically a function of the expiry date images. For example, an option trader may face the situation where the 1‐week contract trades at images, the 1‐month contract trades at 9%, the ...

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