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Ever Wonder What Implied Volatility Has To Do With Option Trading?

Updated: Jan 8, 2019

Implied volatility (IV) is the market’s best guess as to how volatile (or not) a stock is going to be over a certain period of time in the future.


This guess is represented by a percentage number and is factored into the option pricing model to help give the option its value.


You will see a number like 20% IV, which means that the stock in question is expected to fluctuate 20% higher or lower around the current price of the stock for a period of time in the future.


Now, whether that IV estimate is accurate will not be known until the expiration of the option, when at that time, you will see what the actual realized volatility turned out to be.


IV has a direct affect on the price of the option, and if IV is high, then the option’s price will be higher than usual, and if IV is low, the option’s price will lower than usual.


It’s a tricky concept to understand at first, and it fluctuates all the time. It’s not a static number, as it lives and breathes and reacts to the stock’s movement.


In the end, IV is a percentage number that represents a guess as to how volatile a stock is supposed to be in the future, and that guess is used in the option-pricing formula to help give an option its value.


Read my other posts about volatility here and here


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