Implied Volatility
Options TradingQuick Definition
The market's forecast of a likely movement in a security's price, derived from option prices.
Detailed Explanation
Implied volatility (IV) represents the market's expectation of future price volatility and is a crucial component in options pricing. Unlike historical volatility, which measures past price movements, IV is forward-looking and derived from current option prices. High IV suggests the market expects large price swings, while low IV indicates expected stability. IV typically increases before earnings announcements or major events and decreases afterward (IV crush). Options traders use IV to identify overpriced or underpriced options and to implement strategies like selling premium when IV is high.
Real Trading Example
Before earnings, a stock's implied volatility might spike to 80%, making options expensive, then crash to 30% after the announcement.