“Implied volatility” is a term that relates to a security’s estimated future volatility. In most cases, implied volatility increases as the stock market falls and decreases as the stock market rises. The main reason volatility increases in a bear market is because stocks are considered riskier investments than in a bull market. Investors often calculate the implied volatility of option contracts to determine the volatility of the underlying asset. A pricing model is required to calculate implied volatility. Investors commonly use the Black-Scholes model with spreadsheet software or an implied volatility calculator to calculate implied volatility. Understanding how to calculate implied volatility helps you to determine the value of an option contract and its underlying asset.
1. Open your Web browser and navigate to a website that offers an implied volatility calculator, such as VolatilityTrading.net. This calculator allows you to input stock option variables and then calculates the implied volatility.
2. Type the stock symbol associated with the option and click the “Get Symbol” button. A new window opens, displaying current information about the stock option contract. Find the appropriate option on the list.
3. Input the stock price, strike price, option price and days until expiration in the calculator. This information is found on the option list. You can click the calendar and select the expiration date instead of entering the days until expiration.
4. Type the interest rate into the calculator. Locate the interest rate using the Treasury bill rates available on the Treasury.gov website. Look up the rate that corresponds with the duration of your option. If the option is a 120-contract, look up the 13-week Treasury bill rate. Type the interest rate as a percentage.
5. Enter the dividend amount, if the stock paid a dividend. Click the calendar to select the date the company paid the dividend. Select the dividend frequency from the pull-down menu.
6. Select the “Call” or “Put” option button. Call options are located on the top half of the page and put options are on the bottom half.
7. Click the “Calculate” button to get the implied volatility rate. An error will be reported if any of the required information is missing. If this happens, enter the missing data and click the “Calculate” button again.
- The implied volatility rate should not be the only factor used in deciding whether to buy an option contract.
Items you will need
- Implied volatility calculator
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