Implied Volatility - IV

See: Black Scholes.

Your Uncle Harry is volatile. You never know when his mood will shift suddenly. One minute: enjoying Thanksgiving dinner, telling the story about the time he saw Robert Downey Jr. at Starbucks. Next minute: screaming about the government, banging his fists on the table, spilling wine all over the mashed potatoes. (All you said was you liked the Natural History Museum at the Smithsonian.)

Markets get volatile, too. This fact applies both to general markets and to the markets for individual assets, like a particular company's stock.

When volatility is low, the market is fairly stable. Not much movement up or down. Mostly holding steady. Like your Aunt Grace, who just pats Uncle Harry on the back as he rants, while she calmly asks for someone to get paper towels to clean up the spilt wine.

Other markets are closer to the Uncle Harry situation. Very volatile. Lots of wild swings. Up and down, like a roller coaster.

Implied volatility is a prediction about how prices will move in the future. It doesn't imply direction; IV doesn't have an opinion about whether a security will move up or down. It just predicts whether there will be a lot of movement or very little.

Uncle Harry's implied volatility is high. Before any Thanksgiving, you're pretty confident something exciting will happen. However, it can go either way. It's just as likely that Uncle Harry will give you a hug and $100 as it is that he'll start yelling at you about the Yalta Conference.

IV, represented by the Greek letter sigma, is like the consensus view of what the market expects a security's price to do...it's a probabilistic calculation based on various factors. IV represents a key factor in pricing option contracts, since options represent bets on future price movements.