Implied volatility: what the option price says about future moves
Implied volatility is the movement the market is pricing into an option, worked backwards from its premium.
Implied volatility (IV) is the volatility the market is pricing into an option right now. It is not measured from past prices. It is worked backwards from the option's own premium: take the price traders are paying, and find the volatility that makes an option pricing model produce that price.
High IV means options are expensive because traders expect big moves. Low IV means they are cheap. That is why option traders quote IV alongside the premium: it tells you whether the price is high or low for reasons other than where the underlying sits.
Historical volatility vs implied volatility
Source
Historical volatility
Past price changes of the underlying
Implied volatility
Current market price of the option
How it is found
Historical volatility
Standard deviation of, say, weekly Nifty returns over the past year
Implied volatility
An option pricing model such as Black-Scholes run in reverse
Looks
Historical volatility
Backward, at what happened
Implied volatility
Forward, at what the market expects until expiry
Changes when
Historical volatility
New prices are added to the window
Implied volatility
Option premiums change, often sharply around events
| Point | Historical volatility | Implied volatility |
|---|---|---|
| Source | Past price changes of the underlying | Current market price of the option |
| How it is found | Standard deviation of, say, weekly Nifty returns over the past year | An option pricing model such as Black-Scholes run in reverse |
| Looks | Backward, at what happened | Forward, at what the market expects until expiry |
| Changes when | New prices are added to the window | Option premiums change, often sharply around events |
How IV is backed out of a price
The NISM workbook's own example. Every input except volatility is known.
- 1
1. Collect the inputs
Index at 17,562, strike 17,500, 9 days to expiry, interest rate 6%, and the call trading at ₹95.
- 2
2. Leave volatility as the unknown
Black-Scholes needs five inputs: underlying price, strike, time, interest rate and volatility. Four are given.
- 3
3. Solve for volatility
Try volatility values until the model's output equals ₹95. The value that fits is the implied volatility.
Reading an IV number
IV is quoted as an annual figure. A common rule of thumb scales it by the square root of time: 16% annual IV over 30 days is about 16 × √(30/365) ≈ 4.6%, so with Nifty at 25,000 the market is pricing a typical move of roughly 1,150 points either way. Illustrative only: it assumes normally distributed returns, and real moves often exceed it.
How Series VIII tests this
Expect definition questions: implied volatility is derived from the option price, historical volatility from past prices of the underlying. The trap option reverses them, or says IV is set by the exchange or by SEBI. The workbook is explicit that premiums, and so IV, come from the market.
A second pattern asks about direction. If IV rises, call and put premiums both rise (positive vega for buyers). The workbook adds that traders tend to sell options when IV is high and buy when it is low, because high IV means a high premium. Questions treat that as a description of behaviour, not a rule that always pays.
FAQs
What is implied volatility in options?expand_more
The volatility of the underlying that is implied by an option's current price. It is found by putting the market premium into a pricing model such as Black-Scholes and solving for volatility.
Is high implied volatility good or bad?expand_more
Neither. It means options are expensive because the market expects large moves. That costs option buyers more and pays option sellers more for taking on greater risk.
What is the difference between implied and historical volatility?expand_more
Historical volatility is measured from past price changes of the underlying. Implied volatility is worked backward from current option prices and reflects expected movement until expiry.
How is India VIX related to implied volatility?expand_more
India VIX is computed by NSE from Nifty option prices, so it is a market-wide measure of implied volatility for the next 30 days.
Access exam-specific mock tests directly from your Android device.Trusted by learners and rated 4.6★ on Google Play.