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With regards to option pricing in the BS model, if there is an earnings announcement coming up or an anticipated product launch, will the IV be correspondingly high to account for these known events (with unknown outcomes)?

From what I understand of IV, it's the markets assessment of how volatile a stock will be in the next year.

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In short, yes. Implied volatility will capture any expected upcoming material announcements.

There is also supply/demand impact bundled in which may inflate an option price, and by extension increase implied volatility. OTM and ITM options are particularly predisposed to this phenomenon -- which is of course at odds with the traditional BS model assumptions -- the result is referred to as the volatility smile.

Implied volatility is quoted as an annualised measure but isn't necessarily an annual value -- it will correspond to the option time period.

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  • Nice answer overall but I don't think most people in the know agree that the volatility smile is the result of demand/supply issues. Rather, the folks I know believe that it's the result of the non-normality of returns, which breaks the BS assumptions. If you use BS to price, you get a smile, but if you had a pricing model that used the true distribution of returns, you would get no such smile. BS is only a first approximation.
    – farnsy
    Apr 27 '17 at 4:54
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From every article I've encountered, the chicken and egg aspect suggests that IV is produced by looking at options pricing, and calculating the IV from that.

The implication is that whatever is known at that time is included in the price. And that when you see a particular option trade an unusual number of contracts at a given price, the implication is that someone thinks they know something that's not already priced in, i.e. that the current price is not accurate, they can profit on the future event.

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