Implied volatility is a prediction of how much the price of a security will move over a given period of time. It's most often used to price options contracts. Show
Definition and Examples of Implied VolatilityImplied volatility is a measurement of how much a security will move up or down in a specific time period. With stock options, this period will be the life of the contract (i.e., until the options contract expires). By its nature as a predictive measure, implied volatility is theoretical. It's based on how the security is behaving in the market and what's happening with supply and demand around that particular stock option. Fundamentally, it's a measure of the market's expectations for how risky that option is.
NoteImplied volatility doesn't predict which direction a particular security will move, only how much it is likely to move in any direction. It gives traders a way to measure potential risk and reward. How Implied Volatility WorksIf a stock has a price of $100 and an implied volatility of 30%, that means its price will most likely stay between $70 and $130 over the course of the next year. That $30 range on either side is known statistically as one standard deviation. It's possible that the stock could stretch two or even three standard deviations (to a range of $10 to $190), but that likelihood decreases with each additional standard deviation. When you're buying stock options for specific contract periods, however, this yearly IV doesn't tell you exactly what you need to know. To convert this IV to the contract period for a specific option on that stock, you have to take divide that yearly rate into the remaining contract period. You would do this as follows:
Remember, that's only one standard deviation, so the price could still move more than that. Implied Volatility Is Not StaticThere's also the reality that IV can change. In other words, the implied volatility of an option is not constant. It moves higher and lower for a variety of reasons. Most of the time, the changes are gradual. However, there are a few situations in which options change price in quantum leaps—catching rookie traders by surprise.
NoteWhen news is pending for a given stock option (e.g., an earnings announcement or FDA results on a drug trial), buyers are more aggressive than sellers, and that buying demand results in higher implied volatility and therefore higher option premium. Historical vs. Implied VolatilityOne way to understand implied volatility is to contrast it with its opposite type: historical volatility. Unlike IV, historical volatility is a measure of what has actually happened with a security. It measures the average of a security's daily price changes over the past year. Historical volatility can be a helpful measurement for understanding a stock or option's risk level and even for predicting implied volatility. But historical volatility is not a guarantee of what a particular security will do in the future. NoteDo not assume that the current market price of any option or spread represents a fair value for your trade plan. What It Means for Individual InvestorsThis is not a game for beginners. It requires experience to buy options when the news is pending. You must feel confident in your ability to estimate how the option prices are going to react to the news. It is not enough to correctly predict the stock price direction when trading options. You must understand how much the option price is likely to change. Only then can you decide whether it is worthwhile to make the play. Key Takeaways
Was this page helpful? Thanks for your feedback! Tell us why! Other SubmitSources The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy. What is a good implied volatility for options?For U.S. market, an option needs to have volume of greater than 500, open interest greater than 100, a last price greater than 0.10, and implied volatility greater than 60%.
Why is volume important in option trading?For options markets, the volume metric tabulates the number of options contracts bought or sold in a given trading day; it also identifies the level of activity for a particular contract. The greater the volume, the more interest there is in the security.
Do you want high or low implied volatility?High implied volatility is beneficial to help traders determine if they want to buy or sell option premium. It also gives us an idea of how the market is perceiving the stock price to move over the course of a year. High IV means the stock could be more volatile than other low IV stocks.
What is a good volatility percentage?Volatility averages around 15%, is often within a range of 10-20%, and rises and falls over time. More recently, volatility has risen off historical lows, but has not spiked outside of the normal range.
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