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Implied Volatility

In short

Market's forecast of future volatility — derived from option prices

Implied volatility is the market's guess about how much a stock will move. High IV means expensive options (the market expects big moves). Low IV means cheap options. Buy options when IV is low, sell when IV is high.

IV is derived backwards from option prices using the Black-Scholes model. When traders expect big moves (earnings, news), they bid up option prices, inflating IV. IV crush happens after events when uncertainty drops suddenly, destroying option premium.

Formula

Derived from Black-Scholes: IV = σ that equates model price to market price

Thresholds

<20
Low volatility — cheap options
20-40
Normal range
40-60
High — expensive premium
>60
Extreme fear — options very expensive

Related concepts

  • Vega — Vega measures how much an option's price changes when market expectations of volatility change. If you expect a big announcement (earnings, FDA), buy before the event — vega will boost your option's value as uncertainty rises.
  • Delta — If a call has delta of 0.5, it gains $0.50 for every $1 the stock rises. Delta 1.0 means the option moves dollar-for-dollar with the stock. At-the-money options typically have delta near 0.5.
  • Moneyness — Moneyness tells you how far the strike price is from the current stock price. At-the-money (ATM) means strike ≈ current price. In-the-money (ITM) means the option has intrinsic value. Out-of-the-money (OTM) means it doesn't yet.
  • VIX (Volatility Index) — VIX is called the 'fear gauge.' When investors are scared, they buy options to protect themselves, which pushes VIX up. VIX above 30 means real fear in the market. Below 15 means complacency. Extreme fear is often a contrarian buy signal.