Implied volatility(IV) is a measure of the market’s expectations for the underlying’s performance during the life span of the option.
The IV of an option is actually backed out of the price of the option. All the inputs of an options pricing model are known (time to expiration, strike, price, interest rates) except for the volatility that the option is pricing in. So that value can be backed out and allows you to understand the relative value of the option’s price.
This Khan Academy video does a good job of explaining what IV is:
- When IV is high, options will be more expensive to purchase. And low IV will translate to more affordable option prices.
- Heightened implied volatility correlates with bearish sentiment, while low IV suggests a bullish mood.
- If you purchase an option with high IV, you need a much bigger move out of the underlying stock to profit from the trade.
- IV will rise ahead of scheduled events, such as earnings reports and new product launches. Once the anticipated event occurs, IV will immediately drop.
IV in Action: March 2014 NIFTY Options Since Jan
First, lets look at the underlying:
To capture the full move of the NIFTY, you’ll have to look at, at least, a dozen strikes between 5950 and 6900.
IV of calls:
IV of puts:
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