Implied volatility
Not a measure of the past. It is the market's opinion about future movement, backed out of the price people are paying.
Everything that goes into an option's price can be observed except one thing: how much the share will move in future. Nobody knows that.
So the calculation is run backwards. Take the price people are actually paying, hold everything else fixed, and solve for the amount of movement that price implies. That answer is the implied volatility.
Implied volatility does not cause option prices. It is derived from them. Saying “options are expensive because implied volatility is high” is close to circular — the high implied volatility is the expensiveness, restated.
Why it matters anyway
Because it makes different options comparable. A $3 premium on one share and a $9 premium on another tell you nothing on their own. The implied volatilities tell you which is expensive relative to the movement being priced in.
Before and after events
Implied volatility rises ahead of anything scheduled and uncertain — results, a regulatory decision, a central bank meeting. More possible outcomes means a wider expected range, which raises the price of every option on that share.
Buying options just before a known event means buying when they are at their most expensive. The uncertainty you are paying for resolves the moment the announcement lands, and the volatility component collapses — often faster than the share moves in your favour.
The VIX, briefly
The VIX is the implied volatility of options on a broad US index, expressed as an annualised percentage. It is widely called a fear gauge, which is fair, because demand for protection drives it.
It measures what the option market expects over roughly the coming month. It does not forecast direction, and it is not a measure of risk — see volatility is not risk.
Implied against historical
- Historical volatility is a measurement of what already happened.
- Implied volatility is an expectation about what will.
- They differ, often substantially, and the gap between them is itself something traders form views on.