Options & derivatives
Implied volatility
Also called IV
The volatility the market is pricing into an option, derived from its premium.
How it works
Rather than being calculated from history, implied volatility is reverse-engineered from what people are paying. It is the market’s forecast of future movement.
It rises before known events such as earnings and falls sharply once the uncertainty resolves.
Where it misleads people
Buying options before an earnings announcement often loses money even when the direction is right, because implied volatility collapses afterwards. The move has to be larger than the one already priced in.
Related terms
- VolatilityHow much an investment’s returns bounce around their average — the standard measure of risk.
- VIXAn index of the volatility the market expects in the S&P 500 over the next thirty days.
- PremiumThe price paid for an option, made up of intrinsic value plus time value.
- VegaHow much an option’s price changes when implied volatility moves by one point.
- Volatility crushThe sharp fall in option prices after an anticipated event passes.
Mentioned in
More in Options & derivatives
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- Intrinsic value (options)
- Futures contract
- Notional value
- Expiry
- Option
- Derivative
- Option spread
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