complicated formula. You will need a computer to calculate it. Generally, the way it is calculated is to take the options value, compare it to the number of days remaining in the life of the contract and the amount that it is in or out of the money, and then calculate the formula backwards to see what volatility in the futures would be necessary to "imply" the actual premium.
Let me explain volatility in simple language. Volatility affects an option's value in the same way as time does. More volatility means a higher option value. More time means a higher value. Less volatility means a lower option value. Less time means a lower option value. Time and volatility are closely related.
If you have lots of time but no volatility, you will have a low option premium. If you have high volatility but no time left, you again have a low option premium. You need both time and volatility to have a high option premium.
How does volatility affect vertical call spreads that we discussed? Here are the prices of the call options on the December S&P futures as of the close on November 18, 1998:
These two spreads are out of the money. Less volatility will decrease the value of each option and also the value of each spread. If we suddenly had extremely low volatility, these options as well as the spreads would suddenly approach zero.
