Implied volatility (IV) is the market's expectation of how much a stock or index will move over a specific time period, derived from the current market price of an option.
Unlike historical volatility — which is calculated from past price movements — implied volatility is forward-looking. It is what the market, in aggregate, is pricing in as the likely magnitude of future movement.
How IV Is Derived
An option's price is influenced by several factors: the price of the underlying, the strike price, the time to expiry, the risk-free interest rate, and expected volatility. If you know all the other factors and you observe the market price of the option, you can solve backwards for the volatility the market has implied into that price. This is implied volatility.
IV is expressed as an annualised percentage. An IV of 20% means the market expects the underlying to move approximately 20% over the next year — or about 1.25% per month, or approximately 1.3% per week.
IV and Premium
High IV means expensive options. Low IV means cheap options.
When large uncertainty enters the market — a budget announcement, an RBI policy decision, a company earnings release — option buyers pay higher premiums because the range of possible outcomes is wide. IV rises. After the event resolves, the uncertainty collapses. IV falls rapidly. This is IV crush.
A trader who buys a Nifty option the day before the budget, pays elevated IV, and is directionally correct about the movement may still lose money — because the IV collapse after the announcement erodes the option's premium faster than the underlying's movement increases it.
Reading IV in the Option Chain
On NSE's option chain, IV is displayed for each strike. Near-the-money options (strikes closest to the current index price) typically show the most accurate market IV. Deep OTM options may have less reliable IV calculations due to lower liquidity.
India VIX is the NSE's own index of implied volatility for Nifty 50 — analogous to the US VIX. India VIX represents the expected 30-day volatility of Nifty. Reading India VIX alongside Nifty price gives context:
- VIX rising while Nifty falls = fear increasing, market expects further downside
- VIX falling while Nifty is flat or rising = market calm, complacency or stability
- VIX very low (below 12–13) = market is pricing in low volatility, options are relatively cheap
- VIX very high (above 25–30) = market pricing in significant potential movement
Volatility Skew on NSE
Across different strikes for the same expiry, IV is not uniform. In Indian markets, OTM put options (lower strikes) typically carry higher IV than OTM calls at equivalent distance. This is the volatility skew — the market charges a premium for protection against sharp downside moves.
The skew reflects asymmetry in market behaviour: sharp falls tend to be faster and larger than sharp rallies. The options market prices this reality into put premiums.
Practical Uses
- Before major events: Check India VIX or near-money option IV. If IV is already elevated, option buying strategies pay a high price for the move. Selling premium (with proper risk management) may be more advantageous.
- After a period of low IV: When IV has been compressed for weeks, any catalyst can cause an IV spike. Long option strategies benefit if IV expands toward the position.
- Comparing IV to historical volatility: If the current IV (annualised) is significantly higher than the actual volatility the stock has shown over the past 30 days, options may be overpriced relative to realised movement.
For educational purposes only. Profitma is not a SEBI-registered investment adviser or research analyst. Nothing in this article constitutes investment advice.