Trading Topic: implied Volatility

Implied volatility shows the market’s response to the stock’s possible moves, but it doesn’t tell the direction. If the implied volatility is high, the market thinks the stock has potential for huge price swings in either direction, just as low IV implies the stock will not move as much by option expiration.

To option traders, implied volatility is more important than historical volatility because IV affects all market expectations. If, for example, the company plans to forecast earnings or expects a major court ruling, these events will affect the implied volatility of options that expire that same month. Implied volatility helps you gauge how much of an impact news may have on the underlying stock.

How can option traders use IV to make more informed trading decisions? IV offers a move to test forecasts and identify entry and exit points. With an option’s IV, you can calculate an expected range – the high and low of the stock by expiration. Implied volatility tells you whether the market agrees with your outlook, which helps you measure a trade’s risk and potential reward.

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