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Implied Volatility

Volatility is one of the most important factors when pricing options.  When volatility is high, options premiums are relatively expensive; when volatility is low, options premiums are relatively cheap.

Volatility is a measure of the amount and speed of price changes, regardless of directions.   The implied volatility is considered to be the market's forecast of the volatility through the life of the option.  This figure is based on what the price of the options actually are in the market.  Speculators can sometimes compare the implied volatility against historical volatility and buy or sell options accordingly.  It is also argued that implied volatility values that are abnormally higher or lower than historical volatility could indicate a violent movement ahead.

Implied volatility usually differs from strike price to strike price.  Options that are far out of the money or options that are deep in the money will sometimes have a higher volatility than options that are at the money.  This phenomenon is known as "volatility smile".

See Also

Historical Volatility