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The two most basic and popular index options are Call Option and Put Option. Further, they may be American Options or European Options.
A Call Option gives the buyer a right to buy a specified quantity of an underlying index at a pre-decided price. For this privilege, the buyer of the Call Option pays an upfront premium to the seller or writer. A Put Option gives the buyer the right to sell a specified quantity of an underlying index at a pre-decided price; for this privilege the buyer of the Put Option pays an upfront index option is to the Put Option seller or writer.
An American Option may be exercised anytime before the expiry of the contract whereas a European Option can be exercised only on the day of expiry. Sum of strike price of each contract traded today X No of underlying asset in each contract.
Implied Volatility Definition: In the world of option trading, implied volatility signals the expected gyrations in an options contract over its lifetime. Investors and traders use it to determine option pricing.
Many experts in derivatives trading look at this indicator as a more important tool than time value of an option for pricing a contract. Implied volatility alerts an investor of the possibility of uneven changes in the price index option is the underlying make good money right now in, as it is dependent on demand and supply of a particular option contract as well as expectation of the direction of share price.
Description: Implied volatility helps investors gauge future market volatility.
It has a positive correlation with the expectation of stock price and is one of the six parameters used to determine the price of an option. If investors believe the price of a stock will rise in the future, then implied volatility will rise, whereas if they expect the price to fall, then implied volatility will decline.
How does implied volatility affect the price of an option? Lower implied volatility means the price of an option will fall. The time value of an option, talked about earlier, hence becomes cheaper or expensive depending on the fall or rise in implied volatility.
Short-dated options have lower sensitivity to implied volatility whereas long-dated options have higher sensitivity to it as the time value is priced into such option in a higher quantity.