Is the one standard deviation price change in the underlying, in percent, at the end of one year. So a $1.00 item with volatility at 10% should trade between .90 cents and $1.10 by the end of the year, 68.3% of the of the time.

What volatility essentially measures is the speed of the market. Markets that move rapidly have high volatility and ones that move slowly have low volatility.




Measures the speed of the underlying market. (Often referred to as historical volatility)


Is solely related with an option and numerically represents the value of an option above intrinsic value. It is determined by the market place with the willingness of buyers and sellers to determine these values.

These two intertwined yet separate entities are the root of all option trading decisions. Understanding that implied volatility is simply a predictor of what the option market believes actual volatility will be, is an imperative concept. As Dr. Bill Hanlon wrote: " Implied volatility is a forecast, as implied by an option price, of the future volatility of the underlying. Each market participant reveal their forecast through the price paid by the buyer and the price accepted by the seller. They forecast a higher volatility by a willingness to pay higher prices when buying or by holding out for higher prices when selling. Buyer and seller eventually agree on a price and a transaction occurs, thereby revealing their forecasts of future volatility of the underlying. These transaction collectively reveal the markets forecast of the future volatility of the underlying"

However, what people are willing to pay and what value will ultimately be are oftentimes two different things. In an option context; implied volatility equals price while actual volatility ultimately equals value. Obviously, an option's value is subjective as one does not know how the market will move in the future, however, there are numerous tools to act as a guide.



Predicting future events is as arduous task, yet much like the technical trader looks at price charts or a fundamental trader looks at the balance sheet to make educated guesses on price direction an option trader can use historical and seasonal data on both implied and actual data to make educated guesses on volatility movement.

1. Has underlying price movement justified the price, in which buyers and sellers have traded options? Over what periods?
2. Is recent implied volatility trending in one direction? If so, by how much?
3. Are these levels above or below normal volatility levels? If so, by how much?
4. What are the seasonal tendencies of the market? Are the tendencies strong?
5. Does historically high or low underlying price affect implied and historical volatility?

These are just some of the questions one must ask when initiating or exiting an options trade, all with the ultimate intention of identifying whether implied volatility (or price) is greater or less than expected actual volatility (or value).