What Is Implied Volatility?
Implied volatility is the market's forecast of how much a stock will move. It directly drives options premiums — high IV means expensive options, low IV means cheap options.
Definition
Implied volatility (IV) is derived from options prices and represents the market's consensus expectation for how much a stock will move over the coming year, expressed as an annualized percentage. A 30% IV means the market expects the stock to move ±30% over the next year with roughly 68% probability.
IV is forward-looking and demand-driven — when traders rush to buy options (for hedging or speculation), IV rises, increasing all option premiums. When demand falls, IV drops. IV is not a forecast by any individual — it's the collective expectation embedded in market prices.
IV rank (IVR) and IV percentile compare current IV to historical ranges. A high IVR (above 50) suggests options are expensive relative to history — a good time to sell. A low IVR suggests options are cheap — potentially a good time to buy.
Real-World Example
Before an earnings report, NFLX options show IV of 80%. After earnings (regardless of the move), IV drops to 25%. An option buyer paid for 80% IV but is now holding something priced at 25% — this IV crush can destroy value even if the direction call was correct.
Why It Matters
IV is the single biggest driver of option pricing after intrinsic value — understanding whether you're buying or selling options at high or low IV is the difference between a good trade and an overpriced bet.
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Frequently Asked Questions
What is the VIX and how does it relate to implied volatility?
The VIX (CBOE Volatility Index) is the implied volatility of S&P 500 options — it measures the market's expected volatility for the next 30 days. A VIX of 20 means the market expects ~20% annualized moves. When the market fears a crash, VIX spikes (it hit 80+ in March 2020).
When is implied volatility high?
IV rises before binary events (earnings, FDA decisions, Fed meetings), during market uncertainty, and when stocks are in sharp declines. IV is typically highest for individual stocks around earnings season and lowest for index ETFs in calm markets.
Should I sell options when IV is high?
High IV means expensive options — more premium for sellers, higher cost for buyers. Many traders prefer to sell options when IV is elevated (above average) and buy when IV is low. However, high IV exists because the market expects a big move, so sellers face real risk.
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