Last week Ron Ianieri from OptionUniversity.com came and gave us a great lesson on the misinformed traders out there and how options are a great tool (re-read it here), and today I asked him to teach us a bit about volatility and options! If you've not yet checked out Ron's new online video do it today before it's pulled.
The key to having a trade is that you, being the buyer, and me being the seller, have different volatility assumptions. What I think volatility is going to be versus what you think volatility is going to be makes the difference. Everything else we’re in total agreement with because those outputs are “hard numbers” processed by the Options Pricing Model. Current prices, selected strike price, days to expiration, interest rate and dividends are what they are. Just looking at the pricing model output based on these factors is the same for both buyer and seller. But what makes a trade is really the factor of perceived volatility. So, when we talk about volatility we are really talking about the essence of an option trade.