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Say I own an in-the-money call option that I want to sell for profit. I learned that higher volatility leads to an increase in the "price" of a call option in order to compensate for uncertainty, but is this the bid or ask price? Per my example, I would think that higher volatility would make a market-maker buying price (the bid) decrease and the selling price (the ask) increase for the option (ie. the bid-ask spread increases for the market-maker in order to compensate for volatility). Does that imply that the more volatile the underlying stock becomes, the less in value my call option becomes because I would then be selling the option for less (since I'm selling to the bid, or the market-maker's buying price)?

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While it's likely that higher volatility in the stock is likely to result in an increase in option prices, it's not necessarily so.

The primary driver in this is that demand for options results in higher price. Higher option premium means higher implied volatility which is calculated by iteration. Iteration is the reverse engineering of an option pricing model where all known variables (stock price, strike price, time remaining until expiration, carry cost and dividend if any) are plugged into the formula. The volatility variable is incrementally increased until it matches the option's price. That is the implied volatility. It's the volatility that price is implying.

IOW, demand drives option price up which in turn translates into higher implied volatility. The market is determining what your option is worth not the option's implied volatility or the volatility of the stock.

The bid and ask price of a security are determined by the market. If the security is illiquid, there are fewer participants and the market maker sets whatever B/A spread that he likes, subject to regulatory limits. Any trader can become the market on one side of the option by offering a higher bid or a lower ask price, narrowing the B/A spread. For stocks, you can be the market on both sides but not for options.

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    Tacking on rather than adding another answer, OP it also depends on how far in-the-money (ITM) your option is, vega decreases the deeper ITM your option is, which means its price will be less affected by changes in IV than an at-the-money option. – Hart CO Jan 20 at 19:23
  • I'm still a bit confused. By your reasoning, wouldn't increased volatility in the underlying stock then lead to increased market demand for options? Why would this be the case, all things equal? – Victor M Jan 20 at 19:53
  • Stock volatility is a function of price movement in the stock. Implied volatility is a function of price movement in the option. I wrote that that higher volatility in the stock is likely to result in an increase in option prices but that's not a guarantee. It's possible that the stock becomes more volatile but the options don't. Don't get hung up on that possibility. Demand is the driver of of higher option prices. I'd add that risk and fear can also increase option price (see last March) but that's still a function of demand (willingness to trade at a given price). – Bob Baerker Jan 20 at 20:19
  • I see. But why is it higher volatility in the stock is even likely to result in an increase in option prices? If a stock is purely volatile and deviates both positively and negatively around a price, why would the market demand change at all? Even if there were greater potential upside, there's greater potential downside, no? – Victor M Jan 20 at 21:56
  • Deviating both positively and negatively around a price implies that price is range trading between support and resistance. That's not exactly volatility which is rapid and unpredictable price change. If stock volatility increases, it can result in share price movement 3 ways: up, down or nowhere. Higher volatility attracts more traders. Some will trade the stock, some will trade the options. Hypothetically, what happens if those option players are selling to close their options and Open Interest is declines? Does option price rise or fall? Hint: it's not the spring, summer or winter. – Bob Baerker Jan 20 at 22:50

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