762 Part VI: Measuring and Trading Volatility 
benefit if implied volatility merely returns to "normal" levels while you hold the posi­
tion. Of course, having the underlying increase in price is also important. 
Conversely, an option seller should be keenly aware of implied volatility when 
the option is initially sold - perhaps even more so than the buyer of an option. This 
pertains equally well to naked option writers and to covered option writers. If implied 
volatility is "too low" when the option writing position is established, then an increase 
(or worse, an explosion) in implied volatility will be very detrimental to the position, 
completely overcoming the effects of time decay. Hence, an option writer should not 
just sell options because he thinks he is collecting time decay each day that passes. 
That may be true, but an increase in implied volatility can completely domin.ate what 
little time decay might exist, especially for a longer-term option. 
In a similar manner, a decrease in implied volatility can be just as important. 
Thus, if the call buyer purchases options that are "too costly," ones in which implied 
volatility is "too high," then he could lose money even if the underlying makes a mod­
est move in his favor. 
In the next chapters, the topic of just how an option buyer or seller should 
measure implied volatility to determine what is "too low" or "too high" will be dis­
cussed. For now, suffice it to grasp the general concept that a change in implied 
volatility can have substantial effects on an option's price far greater effects than the 
passage of time can have. 
In fact, all of this calls into question just exactly what time value premium is. 
That part of an option's value that is not intrinsic value is really affected much more 
by volatility than it is by time decay, yet it carries the term "time value premium." 
TIME VALUE PREMIUM IS A MISNOMER 
Many (perhaps novice) option traders seem to think of time as the main antagonist to 
an option buyer. However, when one really thinks about it, he should realize that the 
portion of an option that is not intrinsic value is really much more related to stock 
price movement and/or volatility than anything else, at least in the short term. For 
this reason, it might be beneficial to more closely analyze just what the "excess value" 
portion of an option represents and why a buyer should not primarily think of it as 
time value premium. 
An option's price is composed of two parts: (1) intrinsic value, which is the "real" 
part of the option's value - the distance by which the option is in-the-money, and (2) 
"excess value" - often called time value premium. There are actually five factors that 
affect the "excess value" portion of an option. Eventually, time will dominate them