Implied volatility is the volatility figure that, fed into an options pricing model, reproduces the contract's actual market price. It is the model run backwards: instead of asking what an option is worth, you take what it costs and solve for what the market must believe.
That makes IV the market's forecast of future movement — the only forward-looking input in options pricing.
Implied vs historical volatility
Historical (realised) volatility measures what the underlying actually did. It is arithmetic on past returns.
Implied volatility is what the market expects it to do. It is a price.
The gap between them is the volatility risk premium, and it is what volatility traders trade. Implied usually sits above realised — buyers of protection systematically overpay for it, which is the structural reason premium selling has an edge over long horizons. That edge is compensation for taking the tail risk, not a free lunch.
Why IV moves
IV is supply and demand for optionality, not a calculation. It rises when people want protection or leverage — before earnings, into macro events, during selloffs — and falls when they stop.
The most important consequence is the volatility crush. Ahead of a binary event, premium prices the uncertainty. Once the result is public, that uncertainty vanishes and IV drops hard.
This is how traders lose money while being right. You buy calls before earnings, the stock rises 4%, and your calls are worth less than you paid — because IV fell from 90% to 40% and the volatility you bought was worth more than the move you got.
High IV is not "good"
It depends entirely which side you take.
- High IV — expensive premium. Favours sellers: credit spreads, covered calls, cash-secured puts.
- Low IV — cheap premium. Favours buyers: long options, debit spreads, calendars.
But high IV exists for a reason. The market is pricing large moves because large moves are plausible. The fat premium is compensation for real risk, and selling it because it looks generous — without asking why it is generous — is one of the more reliable ways to blow up an account.
Making it comparable
Raw IV tells you little in isolation. Is 45% high? For a utility, enormous. For a biotech before a readout, low.
That is what IV Rank and IV Percentile exist to fix: they place the current reading against the same underlying's own history, so you can tell whether options are expensive for this stock rather than in the abstract.