Over-the-counter option market conventions

Implied volatility as a price metric
One of the most important market conventions in the over-the-counter option
markets is to express option prices in terms of the Black–Scholes implied volatility.
This convention is employed in the over-the-counter markets for options on currencies,
gold, caps, floors, and swaptions. The prices of over-the-counter options on bonds are generally expressed in bond price units, that is, percent of par. It is
generally used only in price quotations and trades among interbank dealers, rather
than trades between dealers and option end-users.
The unit of measure of option prices under this convention, is implied volatility at
an annual percent rate. Dealers refer to the units as vols. If, for example, a customer
inquires about dollar–mark calls, the dealer might reply that ‘one-month at-themoney
forward dollar calls are 12 at 12.5’, meaning that the dealer buys the calls at
an implied volatility of 12 vols and sells them at 12.5 vols. It is completely straightforward
to express options in terms of vols, since as Figure 1.12 makes clear, a price
in currency units corresponds unambiguously to any price in vols. When a deal is
struck between two traders in terms of vols, the appropriate Black–Scholes formula
is used to translate into a price in currency units. This requires the counterparties
to agree on the remaining market data inputs to the formula, such as the current
forward price of the underlying and the money market rate.
Although the Black–Scholes pricing formulas are used to move back and forth
between vols and currency units, this does not imply that dealers believe in the
Black–Scholes model. The formulas, in this context, are divorced from the model and
used only as a metric for price. Option dealers find this convenient because they are in
the business of trading volatility, not the underlying. Imagine the dealer maintaining a
chalkboard displaying his current price quotations for options with different underlying
assets, maturities and exercise prices. If the option prices are expressed in
currency units, than as the prices of the underlying assets fluctuate in the course of
the trading day, the dealer will be obliged to constantly revise the option prices. The
price fluctuations in the underlying may, however, be transitory and random, related
perhaps to the idiosyncrasies of order flow, and have no significance for future
volatility. By expressing prices in vols, the dealer avoids the need to respond to these
fluctuations.