05 Extending Wave Range Understand Market Panic Sentiments

Hello everyone! As mentioned earlier, options prices are influenced by many factors.

Some factors can be directly observed in the market, some can be anticipated and remain relatively stable. In addition, there is a significant uncertainty, which is "volatility".

Understanding volatility is crucial for options trading.

So, what is volatility?

Volatility is an indicator that measures the degree of price changes of underlying assets (stocks), usually expressed in percentage.

If the stock price rises or falls significantly, we say it has a "high volatility".

Conversely, if the stock price rises or falls by a small amount, we call it "low volatility".

Under the same other factors, the higher the volatility of the stock, the higher the theoretical value of the option.

Because the exercise price of options is predetermined, the higher the volatility of the underlying stock, the higher the likelihood of reaching the exercise price, so the likelihood of options being exercised is also higher.

In investing, we not only look at the past, but also the future. This applies to discussions about volatility as well.

We refer to the historical volatility of the underlying stock price as 'historical volatility'.

What's more important than historical volatility is future volatility, which is the 'implied volatility' of options we mentioned earlier.

Implied volatility reflects the market's expectation of future volatility in the underlying stock price and is reflected in the options price being traded.

Traders who only focus on historical volatility are like drivers who only look in the rear-view mirror. This approach can have serious consequences, easily leading to 'crashes'.

In the world of options, we not only look back, but also forward - focusing on implied volatility.

What information can we obtain through implied volatility?

Assuming the implied volatility of a certain options trading is 40%, and the current market price of its underlying stock is $100.

This indicates that the market expects the future price range of the underlying stock to likely fall between $60 and $140 within the next year, with fluctuations of 40% upwards and downwards.

When the market anticipates increased future volatility in the underlying stock price, the implied volatility will rise, and the premium of the options often increases.

Conversely, when the market expects reduced future volatility in the underlying stock price, the implied volatility will decrease, and the premium of the options often decreases.

On the eve of certain major events, such as the release of earnings reports by companies, decisions on interest rates by the Federal Reserve, etc., volatility often rapidly increases, leading to a rise in the premiums of options.

After these major events, volatility often rapidly drops again, leading to a decline in the premiums of options.

Therefore, we can explain a phenomenon: sometimes, the price of call options does not rise simultaneously with the stock price.

This is what we call 'volatility crush'.

Volatility is a bit like swinging on a swing, high volatility cannot be sustained for too long, ultimately tends to return to a relatively 'stable' state, which is known as 'mean reversion'.

Over time, volatility will gradually return to historical average levels.

Therefore, for options traders, they should be cautious when buying options with 'high volatility', because they often have higher premiums and may face the risk of decline at any time.

Implied volatility also plays an important role in evaluating the relative value of options.

Generally speaking, for options linked to the same underlying stock, the higher the implied volatility, the greater the possibility that the options price is overvalued.

The lower the implied volatility, the greater the possibility that the options price is undervalued.

For example, on trading day T(1), if the price of a call option C(1) is $3, with the corresponding stock price S(1) at $50, and the implied volatility σ(1) is 30%.

By trading day T(2), the price of the call option C(2) has increased to $5, with the corresponding stock price S(2) rising to $53, but the implied volatility σ(2) has decreased to 28%.

In this example, at first glance, the price of call options increases as the underlying stock price rises.

However, considering that the implied volatility is decreasing, many traders would think that the relative price of the call options has become cheaper based on this indicator.

Through the above introduction, we can gain a piece of knowledge: by comparing the implied volatility of options with the historical volatility of the underlying stock, we can roughly determine whether the current implied volatility is at a relatively reasonable level, thus evaluating whether the options price is undervalued or overvalued.

On the Futubull App, you can obtain information about options volatility through the following steps:

- Enter the "Stock Detailed Quote Page";

- Click on the "Options" tab;

- Select a specific option to enter the "Options Detailed Quote Page";

- Then click on the "Analysis" tab.

Alright, we'll stop here on the topic of options volatility.

In the next video, we'll talk about how to trade options.

Goodbye!