Understanding Implied Volatility

Easy Option Valuation Implied Volatility

During an options trading seminar, a financial analyst discussed the concept of implied volatility (IV) and its significance in valuing options. Implied volatility represents the market's expectations of future volatility of the underlying asset's price and is derived from the market price of an option. It reflects not only the amount of anticipated price fluctuations, but also the market sentiment regarding potential price movements.

For a given at-the-money call option on a stock with a current price of $50, suppose it has an implied volatility of 30%. This means that the market expects the stock price to fluctuate approximately 30% annually. The analyst emphasized that implied volatility can change over time and can significantly impact option pricing.

Based on this context, which of the following statements about implied volatility is correct?

Implied volatility increases when the market expects lower future price fluctuations.

Implied volatility is generally higher for out-of-the-money options compared to at-the-money options.

Implied volatility cannot be inferred from the price of options.

Hint

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