Question

What is the implied volatility of a stock option? Explain

Answer 1

Implied Volatility is the market estimation of stock movement. Historical volatility is derived from the actual movement of stock price in past, whereas Implied Volatility is the expectation of stock movement in the future. It is determined by the supply and Demand of the stock.

We know that stock options are used to hedged securities. If you buy an option and the stock price doesn't move then the option becomes worthless. So stock option's value is dependent on the movement of the stock price. When the Implied volatility increases the Stock option value increases and vice versa. So when Implied Volatility is low, so stock options value will be low, so you can buy it and sell when Implied Volatility increases.

During market crash, the Implied volatility increases as there is fear in the market and the Stock Option value increases.