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Technology Stocks : Advanced Micro Devices - Moderated (AMD)
AMD 206.89+7.5%12:00 PM EST
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To: niceguy767 who wrote (221880)1/1/2007 8:20:57 PM
From: BiomavenRead Replies (1) of 275872
 
Implied volatility is a function of the average short term view of the price of the underlying shares by current buyers and sellers.

Not true - any such views are reflected only in the current stock price and have no bearing at all on the current implied volatility. The "implied volatility" reflects purely the market's prediction of the volatility of the stock going forwards - it is agnostic about whether the movement will be upwards or downwards. This is surprising, but that is partly why Merton and Scholes won a Nobel Prize for their derivation of the formula (Black would have too had he lived long enough to be eligible).

Really there is an implied volatility (iv) surface rather than a single number because different strikes and contract lengths typically have different iv's. The reason for this is that Black-Scholes makes an over-simplification about how stocks move - it assumes a lognormal distribution, whereas the actual distribution of returns has much fatter tails. Thus you will almost always see a higher IV for a short-term out-of-the-money option than for a long-term at-the-money one, to reflect the larger chance of a short-term jump than is assumed by the lognormal distribution. Hence the so-called "smirk" or "smile" in the IV surface.

Peter
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