Chapter 37: How Volatility Affects Popular Strategies 765 
So now one has the idea of how the excess value is affected by the "big three" 
of stock price movement, change in implied volatility, and passage of time. How can 
one use this to his advantage? First of all, one can see that an option's excess value 
may be due much more to the potential volatility of the underlying stock, and there­
fore to the option's implied volatility, than to time. 
As a result of the above information regarding excess value, one shouldn't think 
that he can easily go around selling what appear to be options with a lot of excess 
value and then expect time to bring in the profits for him. In fact, there may be a lot 
of volatility both actual and implied - keeping that excess value nearly intact for a 
fairly long period of time. In fact, in the coming chapters on volatility estimation, it 
will be shown that option buyers have a much better chance of success than conven­
tional wisdom has maintained. 
VOLATILITY AND THE PUT OPTION 
While it is obvious that an increase in implied volatility ½ill increase the price of a put 
option, much as was shown for a call option in. the preceding discussion, there are 
certain differences between a put and a call, so a little review of the put option itself 
may be useful. A put option tends to lose its premium fairly quickly as it becomes an 
in-the-money option. This is due to the realities of conversion arbitrage. In a con­
version arbitrage, an arbitrageur or market-maker buys stock and buys the put, while 
selling the call. If he carries the position to expiration, he will have to pay carrying 
costs on the debit incurred to establish the position. Furthermore, he would earn any 
dividends that might be paid while he holds the position. This information was pre­
sented in a slightly different form in the chapter on arbitrage, but it is recounted 
here: 
In a perfect world, all option prices would be so accurate that there would be 
no profit available from a conversion. That is, the following equation (1) would apply: 
(1) Call price+ Strike price - Stock price - Put price+ Dividend- Carrying cost= 0 
where carrying cost = strike price/ (1 + r)t 
t = time to expiration 
r = interest rate 
Now, it is also known that the time value premium of a put is the amount by which 
its value exceeds intrinsic value. The intrinsic value of an in-the-money put option is 
merely the difference between the strike price and the stock price. Hence, one can 
write the following equation (2) for the time value premium (TVP) of an in-the­
money put option: