The Phenomena


  • In Options Math For Traders we discuss 5 important phenomena in the option world, all of which can help or hurt your trade. They are:


    The Volatility Risk Premium


    Over time, options cost more than they're worth. This is a benefit to the option seller and a headwind for the option buyer.


    Implied Volatility and Skew


    Strike prices below at-the-money tend to displace higher implied volatilities than strike prices that are above at-the-money. This is a benefit (headwind) to the put seller (buyer) and a headwind (benefit) to the call seller (buyer).


    Time Value and Decay


    Option prices don't erode in a straight line. Erosion accelerates as expiration nears. This helps sellers of short-dated options.


    The Bid/Ask Spread


    The bid/ask spread is very narrow in frequently traded options that are at-the-money or out-of-the-money. The bid/ask spread is wider, often much so, for rarely traded options and deep in-the-money options.


    Volatility Slope


    Implied volatility tends to climb as a stock drops. This is helpful to the put buyer but a headwind for the call vertical spread seller.