Implied Volatility

Implied Volatility is a forward-looking volatility measure implied through the option prices in the market. The price of an option depends on the strike price, tenor, volatility and others. If strike, tenor and others are fixed, you can derive the volatility number directly from the option price.

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Black Scholes Implied Volatility Surface
Black Scholes Implied Volatility

The most useful implied volatility measure is the VIX which is the expected (implied) annualized volatility the options market expects for the US Stock Market S&P 500 over the 30 upcoming days

A VIX of 15 means that the market expects a 15% annualized volatility over the next 30 days. This translates to a 4.33% up or down move in the S&P 500 for the upcoming month (15%/sqrt(12)).

Implied Volatility is calculated explicitely using numerical methods based on the Black Scholes formula which is part of the Options Basics section.

Implied Volatility Calculation Steps

    1. Open the Excel used to calculate Implied Volatility
    2. Input the following data
      • Spot Price (S) = The current price of the underlying asset in the market
      • Strike Price (K) = The price at which the holder of the option can buy (if it is a call option) or sell (if it is a put option) the underlying asset at upon exercise
      • Risk-Free rate (r) = The risk-free rate of return. Usually short term government bond yields are used
      • Time to maturity (T) = The time (in years) until the option expires. In the spreadsheet this is calculated automatically from the number of days until expiry (see “Days”)
      • Observed Option Price (Market Call Premium) = The observed market price of the desired option.
    3. Select in Excel Data > Solver and Click Solve > Solver will use an iterative procedure to return the Implied Volatility