Understanding Implied Volatility

When pricing options, traders often look at the implied volatility, which reflects the market's expectations of future volatility of the underlying asset. The Black-Scholes model can be used to derive the theoretical price of an option based on the underlying asset price, exercise price, time to expiration, risk-free rate, and the implied volatility.

Assume that a call option has a premium of $2.50, with a strike price of $50 and the underlying asset currently trading at $52. An analyst calculates an implied volatility of 20% for the option. Which of the following statements about the implied volatility is TRUE?