The modifications made to the implied volatility parameter used in options pricing models, reflecting market participants’ expectations of future price fluctuations of the underlying asset. These adjustments are critical for accurate options valuation and risk management in crypto markets.
Mechanism
Implied volatility adjustments occur when market makers and institutional traders recalibrate their pricing models in response to new information, shifts in market sentiment, or observed discrepancies between theoretical option prices and actual traded prices. Factors influencing these adjustments include realized volatility, liquidity conditions, supply-demand imbalances for specific options, and macroeconomic news. These adjustments directly impact the bid and ask spreads for options.
Methodology
The strategic objective of making implied volatility adjustments is to ensure option prices accurately reflect perceived risk and future price movement potential, thereby managing the dealer’s exposure and optimizing profitability. For Request for Quote (RFQ) systems, these adjustments are dynamic, influencing the competitiveness and availability of quotes. They are central to managing vega risk, which measures an option’s sensitivity to volatility changes.
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