Stocks quoted in this article:
Chris says - "Nick, As someone just starting out in options I find this very disquieting. That said, it fits in perfectly with the home study course. Could you please expand on Mike's point about using volatilities and theoretical value to "get a better idea of premiums and what you're paying" - perhaps with an example? Many thanks, Chris "
My response - In case you missed it last week, I have begun to start covering the Advanced Home Study Program. As far as the topic of volatilities, I want to start with a quick crash course and then revisit the topic a few times.
As we will see later on the in the course, implied volatility is defined as the assumption of a stock's volatility that helps determine an option's price. In contrast, historical volatility is a statistical measure of past behavior.
In other words, implied volatility is "the market's best guess" of what volatility will be going forward while historical volatility shows you what has been the case. In theory, you can plug historical volatility into an option pricing model to calculate the theoretical value of an option which you can then compare to the actual price to find "overvalued" and "undervalued" options. However, I should point out there are flaws in the option pricing models that make this much more difficult to use in the real world but I am getting off topic...
As far as the question above goes, you can find implied volatility along with historical volatility on the Quotes & Tools page under "Implied Volatility". I went to that page and captured this screen shot that shows the data for General Electric (GE).
As the link above shows, implied volatility for at-the-money GE options was 10-to-12 percent. This is roughly inline with the one-month historical volatility of 13 percent and suggests that the options market is not anticipating a quick increase in near-term volatility.
This story would be very different if an event is coming. For example, implied volatilities on Amazon.com (AMZN) were running high above historical volatility last night, ahead of the earnings announcement. Said another way, the options market was anticipating the potential for an increase in volatility due to the earnings.
I think that covers enough ground for now and we will revisit the topic as we move through the study course. If you have questions on Chapter One, please send them in as we are getting ready to move on to Chapter Two.