Implied Volatility

A changing Stock Price could also impact a Stock’s Volatility. Implied Volatility is the prediction of a Stock’s Future Volatility, calculated via the Black-Scholes model, rearranging it and solving for Volatility.

Implied Volatility for a Stock is an estimation of the level of Volatility in the near term, based on the prospective changes in the Stock Price. The level of Implied Volatility could be used to predict near term demand, supply for a Stock Options Contract. The Greek Vega is the parameter for Volatility, measuring the sensitivity of the Price of a Stock Option to changes in the Volatility of the Stock Price. If the Volatility of the underlying Stock Price increases by 1%, the Vega is the amount by which the Option Price will change. If Volatility increases, the Option Price should increase as the likelihood of the Option being exercised has increased. Thus, benefiting the Option Holder. If Volatility decreases this should benefit the Writer of the Option Contract.

Of course, there are the other Greeks to be considered being Rho, Theta in order to determine which side is more likely to benefit. Implied Volatility can be predicted by rearranging the Black-Scholes Model. Five parameters used in the Model are known to be the Stock Price, the Option Price, the Strike Price, the Risk-Free Rate, and Time to Expiration. Implied volatility isn’t the same as Realised Volatility which measures past changes in the Stock Price, derived from an actual statistical calculation. If Implied Volatility is higher than Realised Volatility, this could potentially indicate that there is an event or information that could impact the Stock Price.