Realized Volatility vs. Implied Volatility (Plain-Language Definitions)
Realized volatility (RV) is what the stock actually did: how much it truly moved around in the recent past. If a stock has been swinging $3–$5 a day lately, its realized volatility is high; if it has been drifting quietly, realized volatility is low.
Implied volatility (IV) is what the options market is pricing in: the level of future movement that would make current option premiums “make sense” given supply and demand. Think of IV as the market’s consensus price of uncertainty for a specific stock, expiration, and strike.
Key point: RV is measured from past price changes. IV is inferred from option prices today and reflects expectations (and fear/hedging demand) about tomorrow.
Why IV Matters So Much to Option Prices
Option premiums tend to be higher when the market expects bigger moves before expiration. If traders believe the stock could jump or drop sharply, they are willing to pay more for options (and sellers demand more) because the range of possible outcomes widens.
In practical terms, IV is a major driver of an option’s premium because it changes the probability that the option will end up meaningfully profitable by expiration. Higher IV generally means higher premiums; lower IV generally means lower premiums.
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| Concept | What it means | What usually happens to option premiums |
|---|---|---|
| Realized volatility rises | The stock has been moving more lately | IV often rises too (not guaranteed), lifting premiums |
| Implied volatility rises | Market prices in bigger future moves | Premiums rise even if the stock price is unchanged |
| Implied volatility falls | Market prices in calmer future moves | Premiums fall; long options can lose value quickly |
How Premiums Can Rise Even If the Stock Price Doesn’t Move (IV Expansion)
It’s possible for an option to gain value even when the stock price is flat, because the market can reprice uncertainty upward. This is called IV expansion.
A Simple Example (Stock Flat, Option Up)
- Stock is at $100 and stays near $100 all day.
- In the morning, the market expects a quiet week (lower IV). A 30-day at-the-money option might trade at, say, $3.00.
- Midday, new uncertainty appears (rumors, upcoming announcement, sector shock, macro headline). Traders bid up options; IV rises.
- By afternoon, even with the stock still near $100, that same option might trade at $3.80.
What changed? Not the stock price. The market’s priced expectation of future movement changed. When IV expands, the “uncertainty component” of the premium expands.
Practical Takeaway
If you buy options, you are not only “betting on direction.” You are also exposed to whether IV rises or falls after you enter. A directional call can lose money if IV drops enough; a call can gain money if IV rises enough, even without immediate price movement.
IV Crush: Why Long Options Can Get Hurt After Big Events
IV crush is the sharp drop in implied volatility that often happens right after a known uncertainty passes (for example: earnings, a major economic release, an FDA decision, or a court ruling). Before the event, traders pay up for options because the outcome is unknown. After the event, uncertainty collapses because the news is out, so IV often falls quickly.
How IV Crush Can Beat a “Correct” Directional Guess
- Before earnings, a stock is $100 and options are expensive because the market expects a big move.
- You buy a call because you think earnings will be good.
- Earnings are good, but the stock only rises to $102 (a smaller move than the market priced in).
- Right after the announcement, IV drops sharply.
Result: even though the stock went up, the call premium can drop because the option was priced for a larger move and then lost value from the IV drop. This is the core lesson: after events, the market often reprices uncertainty downward faster than the stock reprices upward.
Event “Move vs. Priced Move” (A Useful Mental Model)
Before a major event, options often imply a range for how much the stock might move by the next day. If the actual move is smaller than what was implied, long options frequently suffer from IV crush. If the actual move is larger, long options may still do well despite IV dropping.
You do not need to trade events to understand this; you need it to avoid surprises when holding options through known catalysts.
Volatility Is Not One Number: Term Structure and Why Expirations Differ
IV is quoted per option, which means it can differ by expiration. The market can price near-term uncertainty differently from long-term uncertainty.
- Near-term IV higher than longer-term IV: often happens when a specific event is approaching soon (earnings next week). Short-dated options can be especially expensive.
- Longer-term IV higher than near-term IV: can happen when there is broader uncertainty further out (regulatory decisions, macro risk, merger timelines).
This is why you should compare IV across expirations rather than assuming “the stock’s IV” is a single value.
Volatility Skew: Why Puts Often Price Differently Than Calls
Volatility skew means IV varies by strike price. In many equities, out-of-the-money puts often carry higher IV than comparable out-of-the-money calls. This happens largely because:
- Many investors buy puts for downside protection (portfolio hedging demand).
- Down moves can be faster and more disorderly than up moves, so sellers demand more premium for downside strikes.
- Market makers adjust prices to manage risk when put demand is heavy.
Practical implication: two options that are equally far from the current stock price (one call above, one put below) may not be priced “symmetrically.” The put may be more expensive on an IV basis.
How Skew Shows Up on an Options Chain
When you scan strikes, you may see IV increasing as strikes go lower (especially for puts). This is common. It does not automatically mean puts are “overpriced” or calls are “underpriced”; it reflects demand and perceived tail risk.
A Structured Checklist for Interpreting an Options Chain (Volatility-Focused)
Use this checklist to understand whether premiums are being driven by normal conditions or by volatility/event pricing. This is not an event-trading plan; it is a way to avoid entering trades without noticing what the market is already pricing in.
1) Start With the Expiration Comparison (Term Structure)
- Pick two or three expirations (for example: nearest monthly, next monthly, and a farther one).
- Compare the IV level for at-the-money options across those expirations.
- Interpretation: If the nearest expiration has much higher IV than the next one, the market is likely pricing a near-term catalyst or uncertainty window.
2) Check Whether IV Is High or Low Relative to “Normal” for That Stock
- Look at the chain’s IV numbers and, if your platform provides it, compare to a historical IV range (often shown as IV percentile or IV rank).
- Interpretation: High IV suggests expensive premiums and greater risk of IV falling; low IV suggests cheaper premiums and greater risk of IV rising.
If your platform does not show IV percentile/rank, you can still compare today’s IV to the same stock’s IV on different expirations and to nearby strikes; unusually elevated near-term IV often stands out.
3) Identify Event-Driven Pricing Without Turning It Into Event Trading
- Check the calendar for known scheduled items: earnings date, major economic releases (CPI, jobs report), central bank decisions, product announcements, court dates (if relevant).
- Then look back at the chain: is IV elevated specifically in the expiration that contains the event?
- Interpretation: If yes, premiums may be inflated by event uncertainty and vulnerable to IV crush after the event passes.
4) Inspect Skew: Compare Put IV vs. Call IV at Similar Distances
- Choose strikes roughly the same distance from the stock price (e.g., 5% OTM put vs. 5% OTM call).
- Compare their IVs.
- Interpretation: If put IV is meaningfully higher, the market is charging more for downside protection; this is common and affects relative pricing of strategies that involve puts vs. calls.
5) Sanity-Check Premium Changes: Separate Price Move From IV Move
When an option’s price changes, ask two questions:
- Did the stock price move meaningfully?
- Did IV change meaningfully?
Many platforms show IV per option and sometimes show an IV change indicator. If the stock is flat but the option price is up, IV expansion is a likely explanation. If the stock moved in your favor but the option is down, IV crush (or time passing) may be offsetting the directional gain.
6) Practical “Red Flag” Checks Before Buying Options
- Near-term IV spike in the expiration you plan to buy: you may be paying event premium.
- Very steep put skew: downside puts may be expensive; understand you are paying for protection demand.
- Post-event timing: if you are buying right before a known catalyst, assume IV can drop immediately after.
Mini Walkthrough: Reading a Chain in 60 Seconds
- Find the at-the-money strike for the expiration you’re considering and note its IV.
- Compare that IV to the next expiration’s at-the-money IV.
- Scan put strikes below the stock price and see if IV rises as strikes go lower (skew).
- Check the calendar for a catalyst that falls inside the high-IV expiration window.
- Decide what you’re really buying: direction plus volatility exposure (IV up/down), not direction alone.
