[Options Handy Tools] Volatility Analysis: How to estimate an option's value more accurately?

The prices of options with different strike prices and different maturities vary greatly and can not be compared directly.

So, is there a good analysis method to determine whether the option price at a certain point in time may be a better value or not?

The answer is YES. Implied Volatility Analysis, a practical tool on moomoo, can help you estimate an option's potential value more accurately.

Eric will now demonstrate how to do Volatility Analysis on moomoo.

For trading a single option, implied volatility can help us determine a potentially profitable trading direction and measure market sentiment.
For trading multiple options, implied volatility can help us construct an options strategy that can potentially take advantage of future price movement.

Let's now dive into the options tools on moomoo that offer key information about implied volatility.、

Analyzing implied volatility of a single option contract can help us determine a potentially profitable trading direction and measure market sentiment.

The general consensus in the market is that: Implied volatility has a nature of mean reversion, meaning that it tends to revert to its historical average over time.

The implication for investors is the opposite. Without considering the direction (delta neutral). When the implied volatility is low, we may consider buying options. When the implied volatility is high, we may consider selling options.

So, how to determine the level of implied volatility? That will be compared with historical volatility.As a general rule of thumb:

Since implied volatility reflects the market's expectations of the underlying stock's future price movements, it can be an indicator of market risk and uncertainty.

When used in conjunction with the underlying price trend, implied volatility can help us estimate where the market could be heading.

In many cases:

When trading an option strategy that involves multiple options, consider analyzing the differences between their implied volatility.

The volatility term structure refers to the different implied volatility of options on the same underlying asset but with different expiration dates, usually expressed as a curve.

One is the contango structure, shown as the curve sloping upward. This structure suggests that the implied volatility of near-term options is lower than that of longer-term options. In other words, this structure implies that the market expects volatility to rise in the future.

The other type is the backwardation structure, shown as the curve sloping downward. This structure suggests that the implied volatility of near-term options is higher than that of longer-term options. In other words, the backwardation structure implies that the market expects volatility to fall in the future.

After analyzing the volatility term structure, you might identify a noticeable difference between the implied volatility of options with the same strike price but different expiration dates. Thus, it could inform potential option strategies, such as calendar spreads, that align with anticipated changes in implied volatility over time.

Volatility Smile refers to the implied volatility curve of options on the same expiration date. The implied volatility corresponding to different strike prices are different, showing a smile-like shape.

Generally speaking, one of the major reasons for the formation of the volatility smile is the supply and demand of options with different strike prices in the market.

By examining the implied volatility levels of options with different strike prices but the same expiration date, you could construct a vertical spread strategy that aligns with your outlook.

Keep in mind that volatility smiles and skews are theoretical concepts, and the actual market conditions may not always align with the theoretical information shown on a graph. Therefore, traders should exercise caution and use multiple sources of information when making investment decisions.

Well, that's all for the Volatility Analysis sharing. In practical, there are more use scenarios that can be explored.