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Lesson 5: Implied Volatility Intuition

Promise: Know what IV is and why it moves option prices even when spot doesn't.

What Is Implied Volatility?​

Implied Volatility (IV) is the market's expectation of future price movement, expressed as an annualized percentage.

Definition

IV is the volatility number that makes the model price match the market price.

It's "implied" because we work backwards:

  1. We see the market price of an option
  2. We plug in spot, strike, time, and rates
  3. We solve for the volatility that makes Black-Scholes (or another model) output that price

IV Is Not Direction​

IV doesn't tell you which way the price will move, only how much movement the market expects.

High IV
Low IV
Market expects large moves
Market expects small moves
Options are expensive
Options are cheap
Works for both up and down
Works for both up and down
💡

IV is not direction. It's uncertainty priced in.

How IV Affects Option Prices​

Higher IV → Higher option prices (all else equal)

Why? Options are convex payoffs. More uncertainty means:

  • More probability mass in the tails
  • Higher expected value for the option buyer

Drag the slider to see how IV changes the distribution width and option value:

Implied Volatility50%
20% (Low)100% (High)
Current ($100k)$110k call$-50k$250kProbabilityDistributionOTM tail
IV
50%
Moderate
→
Distribution Width
±75%
Expected range (1σ)
→
ATM Option Value
~$20.0k
Higher IV = pricier
Moderate IV. The orange tail shows probability of the \$110k call finishing ITM.

The wide distribution has more probability of extreme outcomes, which increases the value of options.

Practical Implications​

You Can Be Right and Still Lose​

If you buy a call expecting BTC to rise, you can still lose money if:

  • BTC rises, but less than expected
  • IV drops ("vol crush")

Example:

  • Buy call when IV = 80%, price = $2,000
  • BTC rises 3%
  • But IV drops to 50%
  • Call now worth $1,500 → Loss of $500
Key Line

"You can be right on direction and still lose if you overpay for IV."

Vega Risk​

Options are sensitive to IV changes. This sensitivity is called Vega (covered in Lesson 6).

IV vs Historical Volatility​

Implied Volatility (IV)
Historical Volatility (HV)
Forward-looking
Backward-looking
Derived from option prices
Calculated from past returns
What the market expects
What actually happened

They often differ:

  • IV > HV: Market expects more volatility than recently observed
  • IV < HV: Market expects calmer conditions

When Does IV Change?​

IV tends to increase when:

  • Major events approach (earnings, FOMC, protocol upgrades)
  • Market uncertainty rises
  • Large unexpected moves occur

IV tends to decrease when:

  • Events pass ("vol crush" after announcements)
  • Markets become range-bound
  • Uncertainty resolves

Common Mistakes​

MistakeCorrection
"High IV = bullish" or "bearish"IV is about magnitude, not direction. High IV can precede moves in either direction.
Treating IV as historical volIV is forward-looking. Historical vol tells you what happened, not what will happen.
Ignoring IV when buying optionsYou might be buying "expensive" options if IV is elevated.
Expecting IV to stay constantIV changes constantly based on market conditions and events.

IV Levels in Crypto​

Crypto options typically have higher IV than traditional markets:

Asset Class
Typical IV Range
BTC options
40-100%+
ETH options
50-120%+
SPX options
10-30%

High IV means crypto options are expensive in absolute terms, but this reflects real underlying volatility.

Test your understanding before moving on.

Q: If IV increases, what generally happens to option prices?
Q: Can a call price fall while BTC rises? Give one reason.
Q: What does 'IV is priced in' mean?

💡 Tip: Try answering each question yourself before revealing the answer.

See Also​

Navigation: ← Lesson 4: Time Value | Lesson 6: Greeks 101 →