Question

Suppose that you subscribe to a service that gives you estimates of the theoretically correct volatilities of stocks. You note that the implied volatility of a particular stock based on a particular option is substantially higher than the theoretical volatility. What action should you take? Would you buy or sell the option?

Answer 1

if the implied volatility of a particular stock is substantially higher than the theoretical volatility, I will be trying to adjust my implied volatility with respect to taking VEGA NEUTRAL strategies in the market which will be employing at implied volatility hedging and these will be trying to hedge with the volatility of the stock in the respect market.

Volatility of an option is reflected through the VEGA of the option and there is also a heading related to vega of the options so there is a Vega neutral strategy which can be undertaken by the investor in order to neutralize the effect of excess movement of the volatility due to particular event and it will be helping in order to reduce the risk exposure of the investor because of the securities reactiion to the market so I will rather adopt volatility hedging through Vega neutral strategy rather than selling the option.