Implied Volatility IV
The volatility figure backed out of an option's market price — what the market's pricing implies about the size of expected future moves, not their direction.
What it is
Implied volatility is a percentage derived from an option's market price. It answers a backwards question: given what this option is actually trading for, how much movement in the underlying stock must the market's pricing imply? Note the direction — IV is an output extracted from the price, not an ingredient that goes into it. The order matters and is the single most common misunderstanding here. Historical volatility looks backwards at how much a stock has already moved; implied volatility is forward-looking, in the sense that it reflects what today's option prices imply about future movement. It says nothing about which way the price might go — only about how far.
Why it matters
IV is the closest thing to a market-implied consensus on expected turbulence, and it is why two options that look otherwise identical can cost very different amounts. It explains a result that surprises beginners: an option can lose value even when the underlying moves the way its holder wanted, because IV fell at the same time. It also explains why options often carry higher prices ahead of scheduled events like earnings, when uncertainty is high, and cheapen once the event resolves. None of this makes an option safe. A purchased option can expire worthless, costing its holder the entire premium, and a writer of an uncovered call can lose far more than the premium received — theoretically without limit. IV prices that risk; it does not reduce it.
How it's calculated
It is not calculated forward — it is backed out. An option pricing model (commonly Black-Scholes-Merton) takes underlying price, strike, time to expiry, interest rate, dividends where the stock pays them, and volatility, and outputs a theoretical price. Every input except volatility is observable. Implied volatility reverses the model: take the option's market price as given, then find the volatility number that makes the model produce exactly that price. There is no closed-form algebraic solution, so software iterates — trying values and narrowing in until model price matches market price. It is quoted as an annualized percentage, and each strike and expiry has its own IV.