Volatility is the heartbeat of options pricing. Get comfortable with it and a lot of “why did my option do that?” moments disappear.
Two kinds of volatility
- Realized (historical) volatility — how much the stock actually moved in the past.
- Implied volatility (IV) — how much the market expects it to move, derived from current option prices.
You trade against IV. When you buy an option you’re paying for expected movement; when you sell, you’re collecting it.
IV is a price, not a forecast
High IV doesn’t mean the stock will move — it means options are expensive because the market is nervous (earnings, news, uncertainty). Low IV means they’re cheap.
So the real question isn’t “will it move?” but “is the implied move priced too high or too low versus what’s likely?”
IV rank
A raw IV number (say 35%) means little without context. IV rank places today’s IV against its own range over the past year:
IV Rank = (current IV − 52-week low) ÷ (52-week high − 52-week low) × 100
- High IV rank → premiums are rich → favours selling options.
- Low IV rank → premiums are cheap → favours buying options.
The vol crush
Right before an earnings report, IV spikes — everyone expects a big move. The instant the news is out, uncertainty collapses and IV drops hard. Buyers who were “right” on direction often still lose, because the vega loss outran their gain. This is the classic beginner trap.
Skew and smile
Not all strikes share the same IV. Downside puts often carry higher IV than equivalent calls — markets pay up for crash protection. Plotted across strikes this makes a skew (or a volatility smile). It’s the market pricing fear.
The takeaway
Direction is only half the trade. Before you buy or sell, ask: is volatility cheap or expensive right now? Buy options when IV is low, lean toward selling when it’s high.