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In the world of options, the pricing is primarily determined by three essential elements: time to maturity, the current price of the underlying asset, and the implied volatility. While the first two are readily available—the current price is obtained from oracles/dexes, and time to maturity is a known variable—the implied volatility is a dynamic parameter that adjusts based on price demand.
Implied volatility is not the same as realized volatility. Consider an upcoming event, for instance, the unlock of ETH staking. While it's known that the price will see significant movement, the direction of that movement is uncertain. In this scenario, the option market-implied volatility would be higher than usual.
Now, let's discuss how option prices on the Carmine Options AMM adjust automatically.
Firstly, there's the aspect of time to maturity. As an option edges closer to its maturity date, its price naturally declines. This reduction doesn't require any external influence, it's simply a function of time.
Next, we have shifts in the price of the underlying asset. Any changes in this price have an automatic influence on the option's price. Here, prices from external AMMs/oracles serve as input variables. For example, if the price of the underlying asset increases, call option prices rise and put option prices fall.
Finally, we consider changes in volatility. The price of an option alters in response to these volatility shifts, and this change occurs exclusively when external actors trade on the Carmine Options AMM.
In summary, while time to maturity and the current underlying price are relatively static factors, implied volatility is the dynamic element that adjusts with market demands. By understanding these elements, you'll have a clearer perspective on the options price behavior within the Carmine Options AMM. This adaptive attribute of implied volatility is integral to our pricing updates and is a key component of Carmine Options AMM's mechanism.The speed of the change is precisely described below in a chapter Volatility Updates.