How Does Implied Volatility Factor In?

The more volatile a stock (meaning higher SV), the higher the price of its options will be, typically, other things being equal. Implied volatility (IV), however, is another matter.

IV pricing is like being handed a speeding ticket before the event, the State Police officer knew you were going to speed and is charging you for it ahead of time. The risk, in other words, is already priced into the faster driving just like expected volatility gets priced into an option’s value.

The concept of implied volatility is the key to understanding the pricing of options. If SV is a measure of past and current speed, IV can be said to be a form of projected/expected (or future) volatility, which typically manifests in the price of the option (you pay for more volatility).

-John Summa, PhD

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