The degree to which the price of the underlying of an option fluctuates. For an out-of-the-money option, it represents the entire value (the option’ premium or price). The sum of time value and volatility value and intrinsic value equals the premium for an in-the-money option. In equation form, an option’s premium is:
Option premium = intrinsic value + time value + volatility value
The greater the volatility of the underlying, the higher the volatility component of the premium or the price a buyer pays for an option (also the price a seller receives when he writes an option).
The volatility value is also known as an extrinsic value or an opportunity value.
