How Option Market Makers Set Implied Volatility Quotes

Summary

The note explains that option market makers generally set implied volatility quotes in response to the market-clearing balance of buying and selling interest, rather than deriving a single correct volatility from a formula. More demand to buy options can lead a maker to quote higher implied volatility, while stronger selling pressure can prompt lower quotes.

For an option without an established trading history, the response describes a judgment-based starting point: compare volatility levels for similar stocks, consider the underlying’s historical volatility, and adjust for known events such as an upcoming earnings announcement. The account is qualitative and gives no specific pricing model, calibration procedure, or empirical evidence. It presents supply and demand and trader judgment as central, while leaving inventory, hedging, and other market-making considerations outside its brief explanation.

Key ideas

• Market makers adjust option implied volatility quotes in response to buying and selling pressure.
• A new option may be quoted using volatility from comparable stocks as a reference.
• Historical volatility and anticipated events can inform initial implied-volatility judgments.
• The explanation is qualitative and does not provide a formal calculation or calibration method.

Tags

# How do market makers calculate the IV for options?


# How do market makers calculate the IV for options?












This might be silly or basic question but I'm wondering how do a market makers do decide on fixing an option IV on certain level ? how do they do theirs calculations ? Thank you

## Answer by nbbo2 (score 7)

https://quant.stackexchange.com/a/63137

They do not calculate it, they set it at a market clearing level based on supply and demand. It is similar to the way equity market makers set the price of a stock: a lot of buyers => raise the stock price (or the IV), a lot of sellers => lower the stock price (the IV).

For a new option, not previously traded, they might look at the IV of "comparable" stocks and the historical vol of the stock and make some adjustments from there (example: earnings announcement coming up => raise the IV).

It involves judgement and your skill at doing it will determine how good an option marketmaker you are.

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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.