What implied volatility means
Lesson 12 · about 9 min
Every option price contains a forecast. Given the stock price, strike, time to expiration and interest rate, there is exactly one number that makes a pricing model produce the market price, and that number is the market's estimate of how much the stock will move. It is called implied volatility, and once you can read it, an option chain stops being a list of prices and becomes a list of opinions.
The definition
Implied volatility (IV) is the annualised standard deviation of the stock's returns that, plugged into an option pricing model, reproduces the option's current market price. It is quoted as a percentage: "IV 32%" means the market is pricing the stock to move, one standard deviation, about 32% over a year.
The direction of causation matters. Nobody chooses an IV and derives a price. Buyers and sellers agree on a price; IV is read backwards out of it. High IV means options are expensive relative to a low-IV world, and low IV means they are cheap. IV is the price of options, expressed in a unit that lets you compare across stocks, strikes and expirations.
Turning IV into an expected move
Annual figures are not useful for a 30-day trade, so convert:
expected move over N days ≈ stock price × IV × √(N / 365)
XYZ at $50 with IV 32%:
| Horizon | √(N/365) | One-standard-deviation move | Range (±1σ) |
|---|---|---|---|
| 1 day | 0.052 | $0.84 (1.7%) | $49.16 to $50.84 |
| 7 days | 0.138 | $2.22 (4.4%) | $47.78 to $52.22 |
| 30 days | 0.287 | $4.59 (9.2%) | $45.41 to $54.59 |
| 90 days | 0.497 | $7.95 (15.9%) | $42.05 to $57.95 |
| 365 days | 1.000 | $16.00 (32%) | $34.00 to $66.00 |
A one-standard-deviation range is supposed to contain the stock about 68% of the time. So the market is saying there is roughly a two-in-three chance XYZ is between $45.41 and $54.59 in 30 days, and a one-in-three chance it is outside that range. The 16-delta strikes (Module 3) sit approximately at those boundaries, which is why 16-delta is such a common reference point for premium sellers: it is the one-standard-deviation strike.
A quicker version for the market's expected move to expiration, used constantly on trading desks: the price of the at-the-money straddle (ATM call plus ATM put) is about 80% of the one-standard-deviation move, and the straddle price itself is a fine estimate of the expected absolute move. If the 30-day $50 straddle costs $3.75, the market expects XYZ to finish about $3.75 from $50 on average, in either direction.
Reading IV on a chain
Every option on a chain has its own IV. They are not identical, and the pattern of differences (across strikes: skew; across expirations: term structure) is the subject of the last lesson in this module. The single number most platforms display as "the stock's IV" is usually the 30-day at-the-money interpolated value.
Some reference points, with the caveat that these shift with market conditions:
| Underlying type | Typical IV range |
|---|---|
| Broad equity index, calm market | 12% to 20% |
| Broad equity index, stressed market | 30% to 80% |
| Large-cap stock, no event | 20% to 35% |
| Mid-cap stock, no event | 30% to 50% |
| Any stock, week of earnings | Often 1.5× to 3× its normal level |
| Biotech before a binary regulatory event | 100% to 300%+ |
The point is not to memorise numbers but to notice that "32% IV" is meaningless without knowing what is normal for that stock, which is what IV rank and percentile (lesson 3) provide.
Key idea: Implied volatility is the option's price translated into an expected move. Convert it with price × IV × √(days/365) and you have the market's one-standard-deviation range for any horizon.
What IV is not
IV is not a prediction of direction. A 32% IV says nothing about whether XYZ goes up or down; it prices the size of the move either way.
IV is not a guarantee. It is a price, set by supply and demand, and it is wrong constantly, sometimes too high and sometimes too low. The next lesson is about measuring how wrong.
IV is not the historical volatility of the stock. Historical (realised) volatility is what actually happened; IV is what the market is charging for what might happen. They are related and usually close, and the gap between them is where most option strategies make or lose their money.
A worked strike selection using IV
You want to sell a put on XYZ ($50, IV 32%) with 30 days to expiration, at a strike the market thinks has about a one-in-six chance of being breached.
- One-standard-deviation move over 30 days: $4.59.
- One-sigma-down strike: $50 − $4.59 ≈ $45.41; the nearest listed strike is $45.
- Check the chain: the $45 put has delta about −0.16. Consistent.
- Premium: perhaps $0.55, so $55 per contract against a $4,500 obligation.
Now you know what you are being paid for: a one-in-six chance, by the market's estimate, of owning XYZ at $45. Whether that is a good trade depends on whether you think the market's estimate is too high or too low, which is exactly the question the rest of this module equips you to ask.
Try it: Take three stocks with different IVs. For each, compute the 30-day one-standard-deviation move in dollars and as a percentage. Then find the ATM straddle price for the nearest 30-day expiration and compare. Note which stocks' straddles look expensive or cheap relative to how you think they actually trade.
Recap
- IV is the volatility that makes a pricing model match the market price; it is read out of prices, not chosen.
- Expected one-standard-deviation move ≈ price × IV × √(days/365); the ATM straddle price is a quick proxy.
- The 16-delta strikes sit near the one-standard-deviation boundaries.
- IV says nothing about direction and is frequently wrong in either direction.
- A raw IV number needs context: what is normal for this stock, and what is the market expecting to happen.