Volatility measures the market's movement within a price range; the direction of the range is irrelevant. Historical volatility indicates how much prices have changed in the past and is derived by using daily settlement prices for futures. Implied volatility, derived by using the option's premium, measures how much the market thinks prices will change in the future. As volatility increases, so does the value of options, all else remaining equal — for example, the premium for at-the-money $260 gold call options with 90 days to expiration will increase dramatically with incremental increases in volatility:
As prices fluctuate more widely and frequently, the premiums for options on futures increase, since the probability of the options contract attaining intrinsic value or moving deeper into the money increases. Accordingly, options writers demand higher premium payments. If market volatility declines, premiums correspondingly decline.
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