Warrants – Implied Volatility
- March 7, 2022
Implied volatility is a key factor affecting a warrant’s pricing. It is the level of volatility that is implied by the current market price of the warrant, and represented as a percentage.
Implied volatility can be used to compare the relative price of similar warrants. The higher the level, the more expensive the warrant (all other pricing factors held constant).
Implied volatility is influenced by:
- Demand and supply forces
- The level of volatility in market prices generally
- Exchange traded options (ETO) and over the counter (OTC) markets
Supposed you observe the price movement of Call Warrant A on the market to be as such:
Call Warrant A is moving tick-for-tick with the underlying share price, moving up one ‘tick’ (MYR 0.005) for every one tick (MYR 0.01) in the underlying share with the implied volatility remaining constant.
Later in the day, the price movements are as follows:
As highlighted in red, price of Call Warrant A moved up one tick from MYR 0.160 to MYR 0.165 despite the underlying share price remaining unchanged at MYR 5.12. The increase in warrant price is attributed to the increase in implied volatility from 70% to 71%.
What may have caused the implied volatility to increase?
- Increase in demand for the warrant, or
- Market related event causing uncertainty in the market, hence, a higher forecast level of volatility in the market, or
- An increase in the implied volatility level of a similar option in the ETO or OTC market.
Before the market closes, the training pattern of the underlying share and the call warrant are as follows:
Call Warrant A continued to trade tick-for-tick with the underlying share up until 4:00pm when the call warrant declined from MYR 0.190 to MYR 0.185 even though the share price stayed put at MYR 5.16.
What may have caused the implied volatility to decrease?
- Decrease in demand for the warrant, or
- Increase in market confidence, hence, a lower forecast level of volatility in the market, or
- Decrease in the implied volatility level of a similar option in the ETO or OTC market.