Implied Volatility (IV)
Definition
The market's expectation of future price movement embedded in option prices. Higher IV means options are more expensive, reflecting greater expected price swings.
Implied volatility is the market's collective forecast of how much a stock's price will move. Unlike historical volatility (which measures past price swings), IV is forward-looking — extracted from current option prices using pricing models like Black-Scholes.
IV is expressed as an annualized percentage. A stock with 30% IV is expected to move within a range of roughly +/-30% over the next year (one standard deviation). This translates to about +/-8.7% over a month and +/-1.9% per day. Higher IV means bigger expected moves — and more expensive options.
Understanding IV is crucial for option trading success. Buying options when IV is high means paying inflated premiums. Even if you're right about the direction, a subsequent decline in IV can cause your option to lose value despite the stock moving your way. This is called "IV crush" and frequently occurs after earnings announcements, which typically resolve the uncertainty that elevated IV.
The VIX (CBOE Volatility Index) measures the implied volatility of S&P 500 options and is often called the "fear gauge." VIX typically ranges from 12-20 during calm markets and can spike above 40-80 during market panics. High VIX readings often coincide with market bottoms because maximum fear creates maximum opportunity.
For option traders, comparing current IV to historical IV (IV percentile or IV rank) helps determine whether options are relatively cheap or expensive. Selling options when IV is high and buying when IV is low provides a statistical edge, though risk management remains essential.
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Related Terms
Frequently Asked Questions
What causes implied volatility to increase?
IV rises when uncertainty increases: before earnings announcements, during market selloffs, ahead of economic data releases, regulatory decisions, or geopolitical events. Higher demand for options (especially protective puts) pushes premiums up, which is reflected in higher IV.
What is IV crush?
IV crush is a rapid decline in implied volatility, typically after a known event (earnings, FDA decision) removes uncertainty. Even if the stock moves in your direction, options can lose value if IV drops enough. This is why buying options before earnings is risky — you need a big move to overcome the IV decline.