Implied Volatility Options Pricing, Definition
Implied volatility is a theoretical value that reflects the volatility of the security underlying an option as determined by the price of the option. The variables that affect implied volatility are the exercise price, the riskless rate of return, expiration date and the market price of the option.Implied volatility is used in calculating an option's premium. It is used as a variable in several option pricing models, such as the Black-Scholes Option Pricing Model.
Securities with higher volatility have higher option prices. Volatility can be measured is by finding the standard deviation of the underlying security. However, the standard deviation cannot always explain the volatility that is implied by an option's price; the price of an option may reflect more volatility than that measured by the standard deviation. Implied volatility is based on option prices rather than the underlying security. Normally, implied volatility increases when the market is bearish and decreases when the market is bullish.
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