by John Jagerson | September 14, 2010 11:47 am
In my opinion, implied volatility (IV) is the most useful of the option greeks. Implied volatility can be used to adjust your risk control and trigger trades. I will show you how to trade options on the market’s own implied volatility level. Implied volatility is relatively simple to understand but it hard to predict.
It changes as investor sentiment changes and can be very sensitive to the overall market environment. Used correctly, it can forecast market direction and make trading decisions.
Implied volatility is a measure of what investors think about future volatility. This means that it reflects what traders “think” about the potential for the underlying stock or index. That information is extremely useful when you can see and analyze those changes over time.
Implied volatility will rise when traders are concerned about risk or are becoming very fearful. Conversely, implied volatility will fall when investors are very confident or bullish. This matters to option traders because an increase in implied volatility causes a rise in option premiums.
That is bad for option buyers but can be good for sellers. When implied volatility is falling and traders are becoming more bullish, option prices fall and being a call buyer may be a better alternative than being a put seller.
In the video below, we will talk about how implied volatility changes prices and why this matters to investors.
Don’t miss Part Two and Part Three of our implied volatility series.
Source URL: http://investorplace.com/2010/09/understanding-how-implied-volatility-affects-options-traders/
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