Implied Volatility (IV)
Implied Volatility (IV) is the market's forward-looking estimate of how much the underlying will move (annualised, in %), derived by reverse-engineering an option-pricing model (typically Black-Scholes) from the live option premium. High IV = expensi
Implied Volatility (IV) is the market's forward-looking estimate of how much the underlying will move (annualised, in %), derived by reverse-engineering an option-pricing model (typically Black-Scholes) from the live option premium. High IV = expensive options; low IV = cheap options.
Plain-English example
Two days before HDFCBANK's Q4 results, its 1-month ATM call IV jumps from 18% to 32% — the market expects a big move. Premium balloons even though spot is unchanged. After results are announced and uncertainty resolves, IV crashes back to 18% ("IV crush"): a long-call buyer who was directionally right by 1.5% may still lose money because vega losses (from IV drop) exceeded delta gains.
When it matters
- Earnings, RBI policy, budget, election results → IV spikes before, crashes after
- Comparing IV percentile across stocks: high-IV-rank → consider selling options (covered calls, credit spreads); low-IV-rank → consider buying options
- India VIX is essentially the NIFTY-options IV index
IV vs realised volatility
IV is forecast; realised volatility is what actually happened. Persistent gap (IV > RV) is why option-sellers historically earn a "volatility risk premium" — at the cost of fat-tail risk.
SEBI caveat
IV is a model output, not a guarantee. Black-Scholes assumes log-normal returns, which breaks down at extremes. Educational only.