The 6-Week Options Trading Kickstarter: Options Pricing Basics
Steve Smith breaks down the basics of options pricing.
If a volatility-inducing event like an earnings report is anticipated, implied volatility will revert back to the mean after the event. But if there is unanticipated news like a surprise FDA ruling on a drug, IV will spike.
With Fusion set to report earnings on August 9, expect implied volatility to start to creep up in coming weeks -- and then expect it to drop back towards 50%, or close to historical volatility, immediately following the report.
One site that offers an option calculator and historical and implied volatility readings over various time periods is iVolatility.com.
Time Is Square, Man
There’s a basic math formula used in the Black-Scholes model that is a good starting point for understanding the rate of decline in an option’s value due to the passage of time (also known as time decay or theta). Basically, we use the square root of time to calculate and plot time decay. The math involved in the nitty-gritty of evaluating theta can be extremely complex, so focus on this: Time decay accelerates as expiration approaches, meaning that theta is defined on a slope.
For example, if a 30-day option is valued at $1.00, then the 60-day option would be calculated as $1 times the square root of 2 (2 because there is twice as much time remaining). So all else being equal, the value of the 60-day option is $1.41, or $1 times 1.41 (1.41 is the square root of 2). A 90-day option would be $1 times the square root of 3 (3 because there is three times as much time remaining) for an option value of $1.73. (1.71 is the square root of 3).
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.
Copyright 2011 Minyanville Media, Inc. All Rights Reserved.