Implied volatility (IV) is the market's forecast of how much the underlying will move, worked backwards from option prices. When traders expect big moves, they pay more for options, and IV rises. It is quoted as an annualised percentage.
Reading IV
An IV of 20% on a $100 stock implies a one-standard-deviation move of about $20 over a year. For shorter periods, scale by the square root of time: over one month (about 1/12 of a year), that's roughly 20% ÷ √12 ≈ 5.8%, or about $5.80.
Is IV high or low?
Each underlying has its own normal range, so compare IV with its own history:
- IV rank: (current IV − 52-week low) ÷ (52-week high − 52-week low). 0% = at the year's low; 100% = at its high.
- IV percentile: the share of days in the past year when IV was lower than today.
Worked example
A stock's IV ranged from 18% to 48% over the past year. Today it is 30%.
IV rank = (30 − 18) ÷ (48 − 18) = 40%: middle of its range.
IV crush
Before a known event, such as earnings or a central bank decision, IV rises because a big move is possible. Once the event is out, the uncertainty disappears and IV collapses. This IV crush can make options lose value even when the stock moves in the buyer's direction.
| IV environment | Options are | Approaches that tend to suit it |
|---|---|---|
| High IV (high rank) | Expensive | Selling premium, defined-risk spreads |
| Low IV (low rank) | Cheap | Buying options or debit spreads |
| Before a known event | Inflated | Be aware of the crush afterwards |
The VIX
The VIX measures the implied volatility of S&P 500 options over the next 30 days. It tends to rise when stocks fall, which is why it's called the "fear index". It's a useful gauge of risk appetite for any market (Module 11).
Key takeaways
- Implied volatility is the market's forecast of future movement, backed out of option prices.
- Compare IV with its own history using IV rank or IV percentile.
- IV rises before known events and collapses afterwards: IV crush.
- High IV favours selling premium; low IV favours buying; the VIX tracks S&P 500 implied volatility.