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Editor's Notes

1. Volatility is one of the important factors, which is taken into account while pricing options. It is a measure of the amount and the speed of price change. To estimate future volatility, a time-series analysis of historical volatility may be carried out to know the future movements of the underlying. Alternatively, one could work out implied volatility by entering all parameters into an option pricing model and then solving it for volatility. For example, the Black Scholes model solves for the fair price of the option by using the following parameters–days to expiry, strike price, spot price, and volatility of underlying, interest rate and dividend. This model could be used in reverse to arrive at implied volatility by putting the current price of the option prevailing in the market. Putting it simply implied volatility is the estimate of how volatile the underlying will be from the present until the expiry of option. If volatility is high, then the options premiums are relatively expensive and vice-versa. However, implied volatility estimate can be biased, especially if they are based upon options that are thinly traded samples. the option value, Ct, is usually defined as a function of five factors known as the direct determinants of an option value (Cox & Rubinstein, 1985): Ct = f (St, K, T - t, r, v) where St denotes the underlying asset price at time t, K the strike price, r the risk-free interest rate, T-t the time to maturity of the option, and the volatility of the underlying asset returns over the remaining life of the option. Of these direct determinants all except volatility are observable in the market.
2. Volatility is one of the important factors, which is taken into account while pricing options. It is a measure of the amount and the speed of price change. To estimate future volatility, a time-series analysis of historical volatility may be carried out to know the future movements of the underlying. Alternatively, one could work out implied volatility by entering all parameters into an option pricing model and then solving it for volatility. For example, the Black Scholes model solves for the fair price of the option by using the following parameters–days to expiry, strike price, spot price, and volatility of underlying, interest rate and dividend. This model could be used in reverse to arrive at implied volatility by putting the current price of the option prevailing in the market. Putting it simply implied volatility is the estimate of how volatile the underlying will be from the present until the expiry of option. If volatility is high, then the options premiums are relatively expensive and vice-versa. However, implied volatility estimate can be biased, especially if they are based upon options that are thinly traded samples. the option value, Ct, is usually defined as a function of five factors known as the direct determinants of an option value (Cox & Rubinstein, 1985): Ct = f (St, K, T - t, r, ) where St denotes the underlying asset price at time t, K the strike price, r the risk-free interest rate, T-t the time to maturity of the option, and the volatility of the underlying asset returns over the remaining life of the option. Of these direct determinants all except volatility are observable in the market.