What is Implied Volatility (IV)? (2024)

FAQs

What does implied volatility mean? ›

Implied volatility is the market's forecast of a likely movement in a security's price. IV is often used to price options contracts where high implied volatility results in options with higher premiums and vice versa. Supply and demand and time value are major determining factors for calculating implied volatility.

Similarly, when traders do not protect themselves vigorously against strong market changes, their IVs fall. The majority of traders are comfortable with IVs of 20% to 25%.

The calculated IV Rank provides insight into how the current implied volatility compares to its historical range. A higher rank suggests a relatively high current IV, while a lower rank indicates a lower IV compared to past levels.

Implied volatility is calculated by taking the market price of an option and backing out the implied volatility that results in the market price given a particular option pricing model and other input parameters.

IV can change often and will vary from one option to the next, even when the options are on the same underlying stock. All else equal, the higher the IV of an option, the higher the options premium, and therefore a bigger expected price change in the underlying stock.

Implied volatility shows the market's opinion of the stock's potential moves, but it doesn't forecast direction. If the implied volatility is high, the market thinks the stock has the potential for large price swings in either direction, just as low IV implies the stock will not move as much by option expiration.

Implied volatility rank is generally considered to be elevated (i.e. “high”) when it is greater than 50. Extreme levels in IV rank would be 80 and above. Alternatively, when implied volatility rank is depressed (<20) that may be viewed as a potential opportunity to buy options/volatility.

When the implied volatility is low and the premiums are low-priced, it's typically a buyers' market. In a low IV environment, you can consider options buying strategies such as: Debit spreads.

For instance, in high IV environments, traders might focus on strategies that benefit from a decrease in volatility, such as selling options. In low IV environments, traders might choose strategies that profit from an increase in volatility, such as buying options.

Options that have high levels of implied volatility will result in high-priced option premiums. Conversely, as the market's expectations decrease, or demand for an option diminishes, implied volatility will decrease. Options containing lower levels of implied volatility will result in cheaper option prices.

What percentage of implied volatility is good? ›

While a commonly cited “good” IV range is 20% to 25%, the ideal IV can vary greatly depending on the specific asset, strategy, and risk tolerance level. Implied volatility (IV) plays a fundamental role in options trading, affecting pricing and the potential for profit.

It is measured on a scale from 0 to 100. IVP of 0 to 20 is regarded as extremely low IV, 20 to 40 is low, and here, traders look for buying options. IVP above 80 is regarded as extremely high IV, and traders typically look for selling options.

The Impact of Implied Volatility on Options

That is, when IV rises, option premiums will also rise. When IV falls, option premiums will also decline. As a reminder, IV represents how much movement the market expects from the underlying stock during the life span of the option.

On the other hand, if IV percentile in XYZ is 90%, that would indicate that implied volatility had traded below current levels 90% of the time over the previous 52 weeks. That level would therefore indicate that implied volatility was trading at the higher end of its historical range.

IV rank defines where current implied volatility is compared to implied volatility over the past year. For example, a security with implied volatility between 20 and 40 over the past year has a current reading of 30. The security's IV rank is 50 because implied volatility is at the midpoint of the past year's range.