What is Implied Volatility (IV)?
Implied volatility is the market's expectation of how much a stock's price will fluctuate in the future, derived from option prices. Higher IV means the market expects bigger price swings.
Implied Volatility (IV) Explained
IV is crucial for options pricing. When IV is high, options are expensive; when IV is low, options are cheap. Buying options when IV is high is generally a losing proposition because IV typically reverts to its mean (IV crush). This is why buying options ahead of earnings is risky — IV is already elevated, and after the announcement, IV collapses even if the stock moves in your direction.
Real-World Example
Before earnings, a stock's IV is 80% (very high). You buy calls, and the stock beats earnings and rises 5%. But IV collapses to 30% after the announcement, and your calls lose value despite the stock going up. This is 'IV crush' and it catches many new options traders off guard.
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