SPY currently trades at $278, a put option expiring in 7 days against SPY, at this strike price, quotes \$2.40.

This means one person (the option buyer) is betting SPY will quote below $280.40 (278 + 2.40) in 7 days while another person (the option seller) is betting SPY will quote above that.

If we assume the market is made of rational participants who are not doing charity, we could say the options market prices a movement of -0.87% of the underlying, in the coming 7 days.

My question is: how come the 7-day implied volatility is 15.6%?

It is my understanding that implied volatility represents the market consensus about the volatility the underlying will experience in a given timeframe, as expressed by a function of the options prices.

Yes, I'm not considering the risk-free interest rate, the probability of assignment before expiration and a whole lot of other things but, still: none of this justifies an IV 20 times higher. What am I not considering?

  • $\begingroup$ How did you come up with 15.6% ? $\endgroup$ – Ezy Dec 4 '18 at 3:04
  • $\begingroup$ it's the current VIX level and the IV shown by my broker for that particular option. $\endgroup$ – Saturnix Dec 4 '18 at 4:09
  • $\begingroup$ Then i dont know what you’re talking about: IV is annualized where as your -0.87% is a number of a week. What are you comparing ? I am confused by your question. $\endgroup$ – Ezy Dec 4 '18 at 4:10
  • 1
    $\begingroup$ I didn't know IV is annualized. That answers the question... $\endgroup$ – Saturnix Dec 4 '18 at 4:14
  • $\begingroup$ Got it. I’ve put this as answer then $\endgroup$ – Ezy Dec 4 '18 at 5:02

The implied volatility value 15.6% is an annualized number, not a weekly one.


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