Along with the price of the underlying stock and the amount of time until expiration, implied volatility (IV) is a key component in determining an option price. All other things being equal, implied volatility and the option price will move in the same direction. That is, when IV rises, option premiums will also rise. When IV falls, option premiums will also decline.
As a reminder, IV represents how much movement the market expects from the underlying stock during the life span of the option. In that respect, an option buyer is partially buying the market's expectations for that stock.
Once an options position has been entered, rising IV is a positive for the option buyer, as it will increase the price the trader can collect for selling to close the option -- but it's negative for the option seller, as it will become costlier to buy to close the option. On the other side of the coin, declining IV is a negative for the option buyer, and a positive for the option seller.
Whether positive or negative, the impact of IV on option price is greatest on at-the-money and out-of-the-money options. That's because these contracts carry no intrinsic value, and the entire premium is based on time value -- of which IV is a significant component. Conversely, fluctuations in IV will have a relatively muted impact on the value of in-the-money options, as time value accounts for only a portion of the option's worth.
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