What is implied volatility (IV)?
In one line: Implied volatility (IV) is the size of future price move that options prices suggest, shown as a yearly percentage. Higher IV means pricier options.
The idea
Volatility measures how much price has moved. Implied volatility looks forward: it's the move the options market is pricing in.
It's worked backward from what people pay for options. If buyers pay a lot, the market is pricing in bigger swings, and IV is high.
A simple example
A stock trades at $100. Its options show an IV of 30%.
That 30% is a yearly figure. It means the options are priced as if a typical one-year move, one standard deviation, is about ±$30.
To shrink it to one month, divide by the square root of 12, which is about 3.46:
30% ÷ 3.46 ≈ 8.7%, or about ±$8.70 over a month.
That's not a forecast. It's what current option prices imply, using a standard pricing model.
Why it matters
IV is a big part of an option's price.
- High IV: options cost more. Buyers need a bigger move to come out ahead.
- Low IV: options cost less.
IV often rises before known events, like an earnings report, because a big move is possible. After the event, it often drops sharply. Traders call this an IV crush.
The VIX, a well-known "fear gauge," is the 30-day implied volatility of S&P 500 options. More in options trading basics.
A common mistake
Buying an option before earnings, being right on direction, and still losing. Say you buy a Call option and the stock rises 3% after earnings. But IV falls from 80% to 35% overnight. The drop in IV can take more off the option's price than the 3% rise adds.
With options, you're betting on direction, size of move and timing. IV is the market's price on the size part.
Questions
What is a high implied volatility?
It depends on the stock. Compare IV with that stock's own past range, sometimes called IV rank or IV percentile, rather than with other stocks.
Does high IV mean the stock will go down?
No. IV measures expected size of move, not direction. Big moves up and down both count.
How does implied volatility affect option prices?
Higher IV raises the price of both calls and puts, and lower IV lowers them, all else equal. The time-decay side is covered in Theta.
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