How exactly is implied volatility assigned to an option's strike price?
"As I understand it, Implied Volatility represents the expected gyrations of an options contract over it's lifetime.  No, it represents that expected movement of the underlying stock, not the option itself.  Yes, the value of the option will move roughly in the same direction the value of the stock, but that's not what IV is measuring. I even tried staring at the math behind the Options pricing model to see if that could make more sense for me but that didn't help. That formula is correct for the Black-Scholes model - and it is not possible (or at least no one has done it yet) to solve for s to create a closed-form equation for implied volatility.  What most systems do to calculate implied volatility is plug in different values of s (standard deviation) until a value for the option is found that matches the quoted market value ($12.00 in this example).  That's why it's called ""implied"" volatility - the value is implied from market prices, not calculated directly. The thing that sticks out to me is that the ""last"" quoted price of $12 is outside of the bid-ask spread of $9.20 to $10.40, which tells me that the underlying stock has dropped significantly since the last actual trade.   If the Implied Vol is calculated based on the last executed trade, then whatever algorithm they used to solve for a volatility that match that price couldn't find a solution, which then choose to show as a 0% volatility.   In reality, the volatility is somewhere between the two neighbors of 56% and 97%, but with such a short time until expiry, there should be very little chance of the stock dropping below $27.50, and the value of the option should be somewhere around its intrinsic value (strike - stock price) of $9.18."
"Not cumulative volatility. It's cumulative probability density. Time value isn't linear because PDFs (probability distribution function) aren't linear. It's a type of distribution e.g. ""bell-curves"") These distributions are based on empirical data i.e. what we observe. BSM i.e. Black-Scholes-Merton includes the factors that influence an option price and include a PDF to represent the uncertainty/probability. Time value is based on historical volatility in the underlying asset price, in this case equity(stock). At the beginning, time value is high since there's time until expiration and the stock is expected to move within a certain range based on historical performance. As it nears expiration, uncertainty over the final value diminishes. This causes probability for a certain price range to become more likely.  We can relate that to how people think, which affects the variation in the stock market price. Most people who are hoping for a value increase are optimistic about their chances of winning and will hold out towards the end. They see in the past d days, the stock has moved [-2%,+5%] so as a call buyer, they're looking for that upside. With little time remaining though, their hopes quickly drop to 0 for any significant changes beyond the market price. (Likewise, people keep playing the lottery up until a certain age when they're older and suddenly determine they're never going to win.)  We see that reflected in the PDF used to represent options price movements. Thus your time value which is a function of probability decreases in a non-linear fashion.  Option price = intrinsic value + time value At expiration, your option price = intrinsic value = stock price - strike price, St >= K, and 0 for St < K." "One alternative strategy you may want to consider is writing covered calls on the stock you have ""just sitting there"".  This will allow you to earn a return (the premium from the calls) without necessarily having to give up your holding. As a brief overview, ""options"" are derivatives that give the holder the right (or option) to buy or sell shares at a specified price.  Holders of call options with a strike prike $x on a particular security have the right to purchase that security at the strike price $x.  Conversely, holders of put options with a strike price of $x have the right to sell that security at the strike price $x.  Always on the other side of a call or put option is a person that has sold the option, which is called ""writing"" the option.  If this person writes a call option, then he will be obligated to sell a certain amount of stock (100 shares per contract) at the strike price if that option is exercised.  A writer of a put option will be obligated to by 100 shares per contract at the strike price if that option is exercised. Covered calls involve writing call contracts on stock that you own.  For example, say you own 100 shares of AAPL, and that AAPL is currently trading for $330.  You decide to write a Jan 21, 2012 call on these shares at a strike price of $340, earning you a premium of say $300. Two things can now happen: if the price of AAPL is not at least $340 on January 21, then the options are ""out of the money"" and will expire unexercised (why exercise an option to buy at $340 when you can buy at the currently cheaper market price?).  You keep your AAPL stock plus the $300 premium you earn.  If, however, the price of AAPL is greater than $340, the option will be exercised and you will now be required to sell the shares you own at $340.  You will earn a return of $10/share ($340-$330), plus the $300 premium from the call option.  You still make out in the end, but have unfortunately incurred an opportunity cost, as had you not written the call option you would have been able to sell at the market price, which is higher than the $340 strike price. Covered calls are considered relatively safe and conservative, however the strategy is most effective for stocks that are expected to stay within a relatively narrow price range for the duration of the contract.  They do provide one option of earning additional money on stocks you are currently holding, albeit at the risk of giving up some returns if the stock price rises above the strike price." When volatility is higher, the option is more likely to end up in-the-money. Moreover, when it ends up in-the-money, it is likely to be over the strike price by a greater amount. Consider a call option. With high volatility, moves in the stock price are big - both up moves and down moves. If the stock moves up by a lot, the call option holder will benefit greatly. On the other hand, when the stock moves down, below a certain point the option holder does not care how big a down move the stock has. His downside is limited. Hence, the value of the option is increased by high volatility. I know everyone who searches this is looking for this answer. Bump so people are able to get this concept instead of looking all over the web for it. You'll still lose a little bit if you buy a put option at the current price.  No such thing as free hedging. Let's say you have 100 shares of IAU that you bought for exactly $12.50 per share.  This is $1,250.  Now let's say you bought a put option with a strike price of $13 that expires in April 2011.  The current price for this option is $1.10 per share, or $110.  You can sell your IAU for $1,300 any time before the expiration date, but this leaves $60 in time value. The price of the options will always have a time component that is a premium on the difference between the current price and the strike price.  (Oh, forgot to add in commissions to this.) "Following comments to your question here, you posted a separate question about why SPY, SPX, and the options contract don't move perfectly together.  That's here Why don't SPY, SPX, and the e-mini s&p 500 track perfectly with each other? I provided an answer to that question and will build on it to answer what I think you're asking on this question.  Specifically, I explained what it means that these are ""all based on the S&P.""  Each is a different entity, and different market forces keep them aligned.  I think talking about ""technicals"" on options contracts is going to be too confusing since they are really a very different beast based on forward pricing models, so, for this question, I'll focus on only SPY and SPX. As in my other answer, it's only through specific market forces (the creation / redemption mechanism that I described in my other answer), that they track at all.  There's nothing automatic about this and it has nothing to do with some issuer of SPY actually holding stock in the companies that comprise the SPX index. (That's not to say that the company does or doesn't hold, just that this doesn't drive the prices.)  What ever technical signals you're tracking, will reflect all of the market forces at play.  For SPX (the index), that means some aggregate behavior of the component companies, computed in a ""mathematically pure"" way.  For SPY (the ETF), that means (a) the behavior of SPX and (b) the behavior of the ETF as it trades on the market, and (c) the action of the authorized participants.  These are simply different things. Which one is ""right""?  That depends on what you want to do.  In theory you might be able to do some analysis of technical signals on SPY and SPX and, for example, use that to make money on the way that they fail to track each other.  If you figure out how to do that, though, don't post it here.  Send it to me directly. :)" No, if your stock is called away, the stock is sold at the agreed upon price. You cannot get it back at your original price. If you don't want your stock to be called, make sure you have the short call position closed by expiration if it is ITM.  Also you could be at risk for early assignment if the option has little to no extrinsic value, although probably not. But when dividends are coming, make sure you close your short ITM options. If the dividend is worth more than the extrinsic value, you are pretty much guaranteed to be assigned. Been assigned that way too many times. Especially in ETFs where the dividends aren't dates are not always easy to find. It happens typically during triple witching. If you are assigned on your short option, you will be short stock and you will have to pay the dividend to the shareholder of your short stock. So if you have a covered call on, and you are assigned, your stock will be called away, and you will have to pay the dividend. "Writing a put for a stock means you are selling the right to sell you stock. Simply put (er no pun intended), ""writing put options"" means you are selling somebody else the right (a contract) to sell YOU a specific stock at a specific price before a specific date.  I imagine the word ""write"" to refer to the physical act of creating a contract.   The specific price is called the STRIKE and the specific date is the EXPIRATION.  By ""writing a put"", you are agreeing to purchase the stock at a particular price (the STRIKE price) before the expiration.  You get paid a fee, the ""premium"", for agreeing to purchase the stock at the strike price if asked to.  If the holder of the contract decides to make you buy the stock at the strike price, you have to do it.     If the stock never dips below the strike price, then the holder of the put contract (a contract you wrote), will never exercise their right because they'd lose money.  But if the stock drops to zero, you could potentially lose up to your strike price (times the number of shares at stake), if the holder of the contract decides to exercise.   Therefore, ""writing puts"" is a LONG position, meaning you stand to gain if the stock goes up.  FYI - ""LONG"" refers direction (UP!), not duration." To Chris' comment, find out if the assignment commission is the same as the commission for an executed trade. If that does affect the profit, just let it expire.  I've had spreads (buy a call, sell a higher strike call, same dates) so deep in the money, I just made sense to let both exercise at expiration. Don't panic if all legs ofthe trade don't show until Sunday or even Monday morning.