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+758 Part VI: Measuring and Trading Volatility 
+direct manner. That is, an increase in implied volatility will cause the option price to 
+rise, while a decrease in volatility will cause a decline in the option price. That piece 
+of information is the most important one of all, for it imparts what an option trader 
+needs to know: An explosion in implied volatility is a boon to an option owner, but 
+can be a devastating detriment to an option seller, especially a naked option seller. 
+A couple of examples might demonstrate more clearly just how powerful the 
+effect of implied volatility is, even when there isn't much time remaining in the life 
+of an option. One should understand the notion that an increase in implied volatility 
+can overcome days, even weeks, of time decay. This first example attempts to quan­
+tify that statement somewhat. 
+Example: Suppose that XYZ is trading at 100 and one is interested in analyzing a 3-
+month call with striking price of 100. Furthermore, suppose that implied volatility is 
+currently at 20%. Given these assumptions, the Black-Scholes model tells us that the 
+call would be trading at a price of 4.64. 
+Stock Price: 
+Strike Price: 
+Time Remaining: 
+Implied Volatility: 
+Theoretical Call Value: 
+100 
+100 
+3 months 
+20% 
+4.64 
+Now, suppose that a month passes. If implied volatility remained the same 
+(20% ), the call would lose nearly a point of value due to time decay. However, how 
+much would implied volatility have had to increase to completely counteract the 
+effect of that time decay? That is, after a month has passed, what implied volatility 
+will yield a call price of 4.64? lt turns out to be just under 26%. 
+Stock Price: 
+Strike Price: 
+Time Remaining: 
+Implied Volatility: 
+Theoretical Call Value: 
+100 
+100 
+2 months 
+25.9% 
+4.64 
+What would happen after another month passes? There is, of course, some 
+implied volatility at which the call would still be worth 4.64, but is it so high as to be 
+unreasonable? Actually, it turns out that if implied volatility increases to about 38%, 
+the call will still be worth 4.64, even with only one month of life remaining: