If you were all in on a game of Texas Hold’em, you’d probably be experiencing major stress about whether the river would make or break your hand. Your adrenaline spikes.

After the excitement wears off, so does the rush, and you’re back to a nice, even keel.

What Is Implied Volatility?

Just like stress affects adrenaline, the state of the market affects implied volatility (IV). IV measures the market's expectation of how much the price of a stock or other underlying asset is going to move.

It reflects the market’s collective sentiment and assumptions about the chances that the price will swing up or down during the life of an option. Now, IV doesn’t predict whether the price will go up or down; it simply indicates how big of a change the market expects.

Implied volatility also serves as a gauge of market risk and uncertainty. Higher IV often signals greater perceived risk, as the market expects larger, more unpredictable stock price swings. On the other hand, lower IV reflects a calmer market with more predictable stock price moves.

Traders often look for opportunities to sell options during high-IV periods, collecting higher premiums. Alternatively, they tend to buy options during low-IV periods, hoping for implied volatility to rise and increase the option’s value.

What Is Vega?

Vega, one of the Greeks, measures an option’s sensitivity to changes in implied volatility. A high Vega means that IV shifts will affect an option premium more than it would if Vega was low. For example, if an option has a relatively high Vega of 0.10, a 1% increase in IV would increase the option’s premium by $0.10 per share (or $10 per contract).

How Do You Calculate Implied Volatility?

You can immediately see a stock’s value on the ticker, but you can’t just look at a stock and know its IV. Instead, you have to reverse-engineer it through a pricing model. Here are the numbers you need:

Current Option Price: The current market price of the option is the premium traders are willing to pay right now.
Strike Price: The strike price is the agreed-upon price at which you can buy or sell the stock if you exercise the option.
Stock Price: The current stock price determines how far the stock is from the strike price and whether the option is in-the-money, at-the-money, or out-of-the-money.
Time to Expiration: Options lose value as the expiration date gets closer because there’s less time for the stock price to move in your favor.
Risk-Free Interest Rate: The return you would get from a completely safe investment, like a government bond, helps determine how much the option’s potential future payout (the difference between the strike price and expected stock price) is worth in today’s terms.
Dividends (if applicable): If the stock pays dividends, those payments can affect the stock price and, in turn, the value of the option.
Volatility (the unknown): IV is the piece of the puzzle we’re trying to solve. It represents the market’s estimate of how much the stock price is likely to move up or down during the option’s life.

Traders use models like Black-Scholes to speculate premiums based on the metrics listed above. However, these models don’t directly solve for IV. Instead, you make an initial guess for volatility, plug it into the model, and calculate the option’s theoretical price.

If the theoretical price matches the option’s market price, you guessed right, and that’s the implied volatility.
If the two option prices don’t match, adjust the IV estimate and run the formula again.

Continue the trial-and-error process until the calculated price is the same as the market price. The result is the implied volatility, which reflects the market's consensus on the stock's potential for price movement.

Implied Volatility vs. Historical Volatility

Implied volatility and historical volatility are key to making smart decisions when trading options, but they serve different purposes.

Implied Volatility

IV is like a crystal ball showing the market’s best guess about how much the stock price will swing in the future. It doesn’t predict whether the price will go up or down; it just shows the market’s expectations for the size of those moves.

This expectation directly impacts premiums. Higher IV means more expensive options because bigger price swings increase the chances that the option will end up in-the-money. IV is a prediction of market behavior and changes constantly based on market conditions, news, or events like regulatory changes.

Historical Volatility

If IV is a crystal ball, HV is like looking in the rearview mirror. It measures how much the stock’s price has actually moved over a past period, such as the last 30 or 60 days. HV doesn’t directly affect option prices because it only tells you what already happened, not what might happen.

However, traders use HV to compare with IV to gauge whether the market’s expectations are reasonable. For example, if IV is much higher than HV, the market might be overestimating future price swings, which could make options more expensive than they should be. On the other hand, if IV is lower than HV, the market might be underestimating future risk.

The Role of IV in Options Pricing

Implied volatility plays a massive role in options pricing. When traders believe there’s a chance of big price swings, they’re willing to pay more for options, driving up demand. Higher demand raises option premiums because traders see the increased volatility as both a risk and an opportunity.

Understanding the role of IV is critical when trading options, especially around major events. High IV can make options expensive, so buying them requires a significant stock price move to cover the cost of the inflated premium. On the other hand, selling options during high-IV periods can be profitable if you expect IV to drop afterward.

Traders also need to be cautious with timing. Buying options right before big news often means you’re paying a hefty premium due to elevated IV while selling options at that time means you’re taking on the risk of a big price swing.

Volatility Crush

After events like earnings announcements or merger updates, the uncertainty is resolved, and IV often drops sharply because the market no longer expects big price swings. This sudden drop is called a volatility crush, and it can have a dramatic impact on the value of an option you’ve already bought or sold.

If you bought an option before the event, hoping to profit from a big move, the volatility crush could reduce the option’s value even if the stock price moves like you want it to.

If you sold an option, volatility crush works in your favor. The sharp drop in IV lowers the option’s premium, allowing you to buy it back at a lower price or let it expire worthless, locking in your profit.

IV Rank and IV Percentile

Traders use IV rank and IV percentile to put the current level of implied volatility into context by comparing it to the stock’s historical volatility patterns. These tools help answer a crucial question: Is the current IV high, low, or somewhere in the middle relative to past levels?

Implied Volatility Rank

IV rank measures where the current IV stands relative to its highest and lowest levels during a specific period, typically over the last year. It gives traders a snapshot of how “expensive” or “cheap” the current IV is compared to its historical range. For example:

If the IV rank is 80%, the current IV is near the top of its one-year range. This is generally a good environment for selling options because higher IV inflates premiums, allowing sellers to collect more income.
If the IV rank is 20%, the current IV is near the bottom of its range. This is better for buying options because lower IV means cheaper premiums, making it easier for buyers to profit if volatility increases.

Implied Volatility Percentile

Instead of comparing the current IV to its highest and lowest levels, IV percentile looks at how often the stock’s IV has been lower than the current level over a set period. It helps traders assess the likelihood of IV reverting to more typical levels. For instance:

If the IV percentile is 85%, it means IV has been lower 85% of the time over the past year. This indicates the current IV is relatively high.
If the IV percentile is 15%, it means IV has been lower only 15% of the time, signaling low current IV.

IV rank and IV percentile give traders a simple way to compare current IV to past levels, making it easier to decide whether options are overpriced or underpriced.

Strategies for Trading High IV

Implied volatility never stays up forever — the market will eventually reset, and you can benefit if you play your cards right. Here are a few strategies to cash in on the impending volatility crush while keeping risk in check.

Iron Condor

Sell an out-of-the-money call and put, and buy a call and put that are further out-of-the-money for protection. This strategy bets that the stock price will remain stable while implied volatility is high.

That high IV will eventually decrease over time, which lowers the option’s premium. Here’s the key — that also means your stock’s price becomes more and more likely to stay within your short range, increasing your chances of all four of your options expiring worthless. As long as you earned a higher premium from the options you sold than the ones you bought, you profit.

Straddle Sell

A straddle sell works if you expect implied volatility to fall and the stock price to stay stable. You sell both a call and a put at the same strike price while IV is still up, collecting high premiums upfront. Time passes, reducing the options' value. Now, there are two ways to profit:

You can buy the options back at lower premiums, earning the difference.
If the stock stays near the strike price, let them expire worthless, keeping 100% of the premium.

Even if the stock moves slightly and one option is in-the-money, you may still profit if the premiums were high enough and the stock doesn’t move too much.

Credit Spreads: Bull Put Spread and Bear Call Spread

Two popular and relatively safe strategies for high-IV environments are the bull put spread and the bear call spread, both of which involve selling an option with a higher premium and buying another option with a lower premium to limit potential losses.

Bull Put Spread

Use a bull put spread strategy when you expect the stock price to rise or at least stay above a certain level. Sell a put option with a higher strike price and buy a put option at a lower strike price. The premium from selling the higher strike put is greater than the cost of buying the lower strike put; collect the difference upfront.

If the stock price stays above the higher strike price at expiration, both options will expire worth $0, meaning you keep the full premium as profit. You limit your risk to the difference between the two strike prices minus the premium you received.

Bear Call Spread

A bear call spread is the opposite of the bull put spread; use this strategy when you expect the stock price to fall or remain below a certain value. You sell a call option at a lower strike price and buy another call with a higher strike price. The lower strike call’s cost is greater than what you paid to buy the higher strike call, and you earn a net credit upfront.

If the stock price stays below the lower strike price when it reaches expiration, both options expire “out-of-the-money”, and you keep the entire premium which is your profit. The most you can lose is the difference between the two strike prices, less the earned premium.

Managing Risks with Low IV

How to manage risk when implied volatility is low

When IV is low and options are cheap, there are a couple of ways to manage risk while positioning yourself for potential market moves without overpaying.

Bull Call Spread

A bull call spread profits if the stock price rises. You buy a long call near the current market value and sell a cheaper short call with a higher strike price.

If the stock rises above the short call’s strike price, you reach your maximum profit, capped by the difference between the strike prices minus the net premium paid. The long call gains value as the stock rises, but the short call limits further gains.

If the stock stays the same or falls, both options expire worth $0, and you have limited your loss to the net premium you paid upfront.

Long Strangle

In a long strangle, you buy a call option with a strike price above the stock’s current market value and a put option at a strike price below its current value.

The goal is to profit from significant price movement in either direction. If the stock rises sharply, the call option gains value. If the stock drops significantly, the put option is worth more. Either way, you cap your maximum loss by the total premiums you paid for both options if the stock price stays stable and doesn’t move enough to cover the cost of the options.

Examples of IV Impact on Trades

Changes in IV matter primarily if you plan to sell your option before it expires because IV directly impacts the option’s premium. As IV increases, the premium rises, and it shrinks when IV decreases.

If you hold the option until expiration, its value will depend solely on the stock price relative to the strike price, and changes in IV become irrelevant. However, if you intend to sell the option early, shifts in IV can significantly influence your profit or loss, regardless of how the stock price moves.

IV Surge

$BRK.B is trading at $476, and IV is low at 20% because the market is stable with no major events currently priced in. However, you anticipate a surge in volatility due to a potential surprise announcement or significant market-moving news. To prepare for this IV spike, you implement a long strangle strategy.

Buy 3 call options at a $490 strike price for $5 per share (paying $1,500).
Buy 3 put options at a $460 strike price for $6 per share (paying $1,800).

The total cost is $3,300

The company announces an unexpected major acquisition, causing IV to spike to 40% and the stock price to move to $500 before expiration.

The call option gains intrinsic value: $500 (stock price) – $490 (strike price) = $10 per share. Each call option is now worth $1,000, ($3,000 total).
The put option loses value but retains extrinsic value due to high IV: Even though the stock moved against the put options, the IV spike keeps them priced at $3 per share extrinsic value, making them worth $300 ($900 total).
The combined value of the options is $3,000 (calls) + $900 (puts) = $3,900.

Your total profit is $3,900 - $3,300 (total cost) = $600 profit.

Low IV

$NVDA is trading at $144, and IV is low at 20% due to calm market conditions. You anticipate that the stock will experience a large move in either direction, possibly due to unexpected developments or broader market shifts. You use a long straddle strategy to take advantage of the low premiums.

Buy 5 call options at a $145 strike price for $4 per share (paying $2,000).
Buy 5 put options at a $145 strike price for $3.50 per share (paying $1,750).

Your total cost is $3,750.

The stock makes a significant move after unexpected market news, jumping to $160 by expiration.

The call option gains intrinsic value: $160 (stock price) – $145 (strike price) = $15 per share. Each call option is now worth $1,500, a total of $7,500 for 5 contracts.
The put option expires worthless: The stock price is above the strike price of $145, so the put options have no value.

Your net profit is $7,500 (call value) – $3,750 (total cost) = $3,750 profit.

IV Drop

$AMZN is trading at $198, and IV is elevated at 45% due to speculation about a new Echo device announcement. Anticipating that the stock price will go up and then remain stable after the news, you employ an iron condor strategy.

Sell 10 call options at a $210 strike price for $4 per share (collecting $4,000).
Buy 10 call options at a $220 strike price for $2 per share (paying $2,000).
Sell 10 put options at a $185 strike price for $5 per share (collecting $5,000).
Buy 10 put options at a $175 strike price for $3 per share (paying $3,000).

You receive a total net credit of $4,000

After the announcement, $AMZN remains relatively stable and closes at $195 at expiration.

The $210 call and $220 call expire worthless because the stock is below $210.
The $185 put and $175 put also expire worthless because the stock is above $185.

Since all options expire worthless, you keep the entire $4,000 credit as profit.

Know When To Hold and When To Fold With Implied Volatility

Back to that game of Hold’em: Just like in poker, measuring implied volatility and knowing when the market’s bluffing or truly volatile helps you adjust your strategy, whether you’re playing aggressively or folding to minimize risk.

Now, don’t go trying to calculate IV with a pencil and paper. Maybe you can get through the Black-Scholes algorithm on your own, but that’s a lot of paper and at least three pencils. Stay true to your degenerate roots — try Option Royale’s online options calculator instead, skip the headache, and spend your time executing trades rather than doing boring math.