If IV (Implied volatility) = 25 and SV (statistical volatility) = 50, we create a situation where options would beconsidered “undervalued” (IV<SV).
Here SV is an input into the formula that produces a fair value price. When market price is greater than the fair value price, options are considered to be “overvalued” and when below fair value price, “undervalued.
In terms of SV and IV, this manifests in IV > SV in for “overvalued” options and IV < SV for “undervalued” options. But if IV=SV, we have no mispricing from a theoretical point of view.
-John Summa, PhD
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