Implied volatility (IV) is a metric that captures the markets view of the likelihood of changes in a given securitys price. In options trading, IV is the short-term sentiment about a particular given stock that drives the option prices. It is one of the six essential factors used in options pricing models, and it represents the current market price for volatility or the fair value of volatility based on the markets expectation for movement over a defined period of time. IV is forward-looking and represents expected volatility in the future. As IV rises, options prices rise because the expected price range of the underlying security increases. Higher volatility equates to a larger range of potential outcomes.
In options trading, IV is often used to price options contracts where high implied volatility results in options with higher premiums and vice versa. It is also used to produce confidence ranges for the terminal price of an asset by a certain date. IV is traders collective expectation of realized volatility in the future for an option contract.
IV is constantly changing with market conditions, and it is affected by several factors, including supply and demand, time value, and market sentiment. During periods of high volatility, investors may choose to look at the IV when they choose an investment. When trading options become unpredictable, this leads to an increase in implied volatility, referred to as IV expansion, because the option prices are likely to increase. When the market scope becomes relatively stable, this is called IV contraction because here, there is a decrease in implied volatility and option prices.
In summary, IV is a metric that captures the markets view of the likelihood of changes in a given securitys price. It is used in options trading to price options contracts and produce confidence ranges for the terminal price of an asset by a certain date. IV is traders collective expectation of realized volatility in the future for an option contract and is affected by several factors, including supply and demand, time value, and market sentiment.
