Implied Volatility
Options
What it means
The market's expectation of how much the underlying asset will move over the life of the option. High implied volatility means options are more expensive (higher premiums) because large price swings are expected, while low implied volatility means options are cheaper. Implied volatility is derived from the option's current market price, not from the underlying's actual price movements.
Example
Before a company reports earnings, implied volatility for its options often rises because the market expects a large price move. A call option might cost $5 per share before earnings, compared to $2 per share after earnings are released and the price move is confirmed.
Mistake beginners make
Beginners buy options when implied volatility is very high, then lose money even if the underlying moves in their direction because the sharp drop in implied volatility after the event (like earnings) reduces the option's value more than the underlying move increased it.
Related terms
- Option Premium — The price you pay per share to buy an option contract. The total cost of the option is the…
- Call Option — A contract that gives you the right (but not the obligation) to buy 100 shares of an under…
- Put Option — A contract that gives you the right (but not the obligation) to sell 100 shares of an unde…