Options prices can change dramatically even when the underlying market price hasn’t changed very much and not a lot of time has passed.
The main reason why this happens is because of a change of the “Implied Volatility” in the options.
Briefly, it’s worth pointing out that there can be other reasons for quick changes in options values that are not caused by price or time such as dividend payments and interest rate changes. For now, we will focus on the more common cause which is Implied Volatility.
Many textbooks like to dive deep into math formulas and the many theories involved in pricing implied volatility. We will focus on the practical aspects and, more importantly, real examples.
Markets can go literally from one moment to the next and have a collective change in expectations about how much an asset price will move.
Scheduled announcements such as quarterly earnings of a stock provide a great example. This information is a known unknown. That means everyone is aware that the information will be available at a specific time. They also know that they don’t know what that information will be.
This known unknown creates a swelling of option values because much of the reason why a company’s stock value may change is related to its earnings. Once the information is known, the options market almost immediately adjusts to represent the impact of the now known information.
One more note before we get into the examples. There are a lot of traders in the options market who focus almost entirely on event-driven opportunities — such as options earnings plays.
Some of the most volatile movements occur around scheduled events. An otherwise liquid options market can become illiquid around these announcements and it can be difficult to control risk. One should spend a lot of time studying the specific risks associated with event-driven options strategies.