Implied volatility (IV) is the volatility input that makes an option-pricing model match the option's market price. It summarizes how expensive option protection or optionality is relative to the model's other inputs.
How it works
Option prices depend on variables including the underlying price, strike, time to expiry, interest rates, dividends, and volatility. Holding the other inputs fixed, more expensive options generally imply higher volatility.
IV is not the same as realized volatility. Realized volatility describes how much prices actually moved; implied volatility is derived from option prices and concerns the market's pricing of future uncertainty.
Why it matters
IV affects option premiums and is central to volatility indices such as the VIX. High IV can make options expensive even if the investor's directional view is correct.
Implied volatility measures expected magnitude, not whether the underlying will rise or fall. Both calls and puts can become expensive when demand for options increases.
A simple market example
Investors aggressively buy short-dated calls during a rally. Call prices rise, and implied volatility can increase even though the underlying stock index is also moving higher.
Common mistakes
Reading high implied volatility as a direct bearish signal.
Assuming implied volatility is a precise forecast of future realized volatility rather than a market price influenced by supply, demand, and risk premia.
Frequently asked questions
Does high IV mean prices will fall?
No. IV is about expected movement size, not direction.
What is realized volatility?
It measures actual historical price variation over a chosen period.
Why does IV change when option demand rises?
Higher option prices, with other model inputs unchanged, translate into a higher implied-volatility estimate.
Educational content only. Definitions describe common market usage and may vary by jurisdiction, instrument, or institution.