Stock Market · Options Theory

Implied volatility (IV) explained

Implied Volatility (IV) is the market's forward-looking estimate of how much the underlying will move over the remaining life of the option. It's derived from the option's market price using the Black-Scholes model.

IV vs historical volatility

Historical volatility (HV): how much the underlying actually moved in the past. Measurable.

Implied volatility (IV): how much the market EXPECTS it to move in the future. Extracted from option prices.

IV is a reflection of fear and uncertainty. It rises when markets are nervous and falls when they're complacent.

India VIX

India VIX is NSE's volatility index. A real-time measure of implied volatility extracted from Nifty option prices. It represents the expected annualised volatility over the next 30 days.

VIX 12–14Low volatility, complacent market. Options are cheap.

VIX 18–22Elevated. Options are expensive.

VIX 30+Panic. Option premiums inflated. COVID March 2020: India VIX hit 84.

The mean reversion of IV

IV tends to mean-revert. High IV eventually falls; low IV eventually rises. Professional traders often sell options when IV is very high (expecting it to fall) and buy when IV is very low (expecting it to rise).

> Selling options during high IV periods (VIX 25+) and buying during low IV (VIX below 12) is a statistically backed strategy, but requires strong risk management.

IV percentile

Rather than absolute IV, compare current IV to its own historical range. IV Rank (IVR) = where current IV sits in its 52-week range. IVR of 80 = IV is in the top 20% of its past year's range. Expensive. Good time to sell premium.

Takeaway. IV is the market's expected volatility embedded in option prices. India VIX tracks this for Nifty. High VIX = expensive options (sell premium). Low VIX = cheap options (buy options). IV mean-reverts.