Derivatives · Pro · 4 min

Implied vs. historical volatility

You can tell implied from historical volatility, read the VIX index, and explain why option prices can fall after an expected event even if the price moves.

Stock up, call down?

A trader buys a call option before a company's results. The results are good, and the stock rises 4%. The next morning, the call is worth less than the trader paid.

It feels like the market cheated. In fact, the trader paid for something that was gone the moment the results came out: expected volatility. This lesson explains the two kinds of volatility and why only one of them sets option prices.

Looking back vs. ahead

Historical volatility measures how much a price has actually moved over a past period, usually as the annualized standard deviation of daily returns. It looks back. As the lesson on volatility explained, it describes how bumpy the ride has been.

Implied volatility is the volatility the market prices into options today. It is the value that makes a standard option pricing model match the option's market price. It looks ahead and reflects what traders expect, and how much they are willing to pay for protection.

The best-known measure is the VIX index. Cboe describes it as a gauge of the market's expectation of 30-day volatility of the S&P 500, derived from S&P 500 option prices. It is annualized: Cboe notes that a VIX of 16 means an expected move of about ±16% over a year, or about ±1% per day. Cboe also stresses that the VIX does not, and is not intended to, give insight into tomorrow's market direction.

Implied volatility drives an option's time value, as the vega lesson showed:

Before scheduled events, such as results or central bank decisions, implied volatility often rises, making options more expensive.
After the event, the uncertainty is resolved, and implied volatility often falls sharply. Traders call this a volatility crush.

An option buyer profits only if the actual move is larger than the move that was priced in.

Priced 7%, got 4%

Before a fictional company's results, its options imply a move of about 7% on the day.

A trader buys a call for 3.00.
The results are good, and the stock rises 4%.
Implied volatility falls from very high levels back to normal. The call is now worth 2.40.

The trader was right about the direction and wrong about the size. The 7% move priced into the option never came, and the gap cost 20% of the premium.

Common mistakes

Buying options just before known events. Implied volatility is often highest then.
Reading the VIX as a direction signal. It measures expected size, not direction.
Comparing historical and implied volatility without context. Events change expectations.
Ignoring vega. A fall in implied volatility can cancel a correct directional bet.

The takeaway

Historical volatility measures past swings, implied volatility the swings priced into options. When the expected event passes, implied volatility often drops.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the measure that reflects what the market expects for the future.

Tap the chart.

Implied volatility is the volatility that makes an option pricing model match the market price of the option.
2What does the VIX index measure, according to Cboe?

Cboe calls the VIX a gauge of 30-day forward-looking volatility, derived from SPX option prices.
3The VIX is at 16. What does Cboe say that roughly corresponds to?

VIX is annualized. Cboe notes 16 corresponds to a daily range of about ±1%.
4A company reports results, and the stock moves 4%. The options were priced for a 7% move. What often happens to the option prices?

The move was smaller than priced in. The uncertainty is gone, so time value shrinks, often called a volatility crush.

of 4 correct.