Implied volatility (IV)

Implied volatility (IV) is the market's forecast of how much a stock's price will move, expressed as an annualized percentage and derived from the current prices of its options. Higher IV means more expensive options and a larger expected move.

How it works

An options pricing model such as Black-Scholes takes the stock price, strike, time to expiration, interest rates, dividends and volatility, and returns a theoretical price. IV runs that in reverse: given the option's actual market price, it solves for the volatility that would justify it.

IV is quoted as a one-standard-deviation annual move. A stock at $100 with 32% IV is priced for roughly a 68% chance of finishing the year between $68 and $132. To scale it to a shorter window, multiply by the square root of the fraction of a year: over one month, 32% x sqrt(1/12) is about 9.2%, or about $9.

Each strike and expiration has its own IV. The pattern across strikes is called skew, and the pattern across expirations is the term structure. Traders often compare current IV with its own history using IV rank or IV percentile. The VIX index is a 30-day implied volatility measure for the S&P 500, calculated from SPX options.

Why it matters for traders

IV is the biggest swing factor in option prices that is not directly observable. It typically rises into scheduled events such as earnings, PDUFA dates and trial readouts, then falls sharply after, an effect known as IV crush. A sudden IV spike without a known catalyst can hint that someone expects news, which is one reason traders watch it alongside unusual options activity.

Sensitivity of an option to IV changes is measured by vega.

Example

Northwind Therapeutics (NWTX) normally trades with IV around 50%. With a PDUFA date in two weeks, front-month IV climbs to 140%. Options are now pricing a much larger move, and an ATM call that cost $2.00 a month earlier might cost $4.50 even if the stock has not moved.

FAQ

Is high implied volatility good or bad?

Neither. High IV means options are expensive, which favors sellers and penalizes buyers unless the stock moves more than expected.

What is the difference between implied and historical volatility?

Historical volatility measures how much the stock actually moved in the past. Implied volatility is what option prices say the market expects going forward.