Module 8 · Lesson 5 of 13 · Options · About 5 minutes
Implied Volatility and the Expected Move Explained
On this page
Before you read: The Option Greeks in Plain Language: Delta, Gamma, Theta, Vega
What you will learn
- The difference between historical volatility and implied volatility.
- How an expected move is estimated from implied volatility or from option prices, and what it does and does not mean.
- What IV rank, IV percentile and volatility skew describe.
What is volatility in options terms?
Can you measure how much a price moves without saying which way?
Volatility describes the size of price changes regardless of direction. Options markets express it as an annualized percentage, a scaled version of the standard deviation of returns.
- Historical (realized) volatility is calculated from past price changes over a chosen window, such as the last 20 or 30 trading days.
- Implied volatility (IV) is the volatility number that, plugged into a pricing model with the other known inputs, reproduces the option’s current market price. It is backed out of the price, not observed directly.
Historical volatility describes what happened. Implied volatility describes what the option price currently embeds. Neither one is a promise about future movement.
How is an expected move estimated?
If the options market prices in movement, can you turn that into a price range?
First name the statistic. A model one-standard-deviation scale and an ATM-straddle premium are not the same quantity. Neither is a direction forecast or guaranteed boundary.
1. Annualized-IV scale. For a short-horizon, locally linearized illustration, assume constant annualized volatility σ, zero drift in the approximate price-change distribution and a consistent calendar-day clock. Define the scale:
price-change SD scale ≈ S × σ × √T, with T = calendar days/365 years.
Fictional S=$400/share, σ=20% per square-root year (0.20), 30 calendar days remaining. T=30/365≈0.08219178 year; √T≈0.28669109 square-root year. Thus $400/share × 0.20/√year × 0.28669109√year = $22.9353/share, or about $22.94. The symmetric illustrative band is $377.0647 to $422.9353, rounded $377.06–$422.94. This is an approximate price-change SD scale, not the exact terminal-price distribution of a lognormal model.
Using 252 trading days requires a matching trading-day volatility/time convention and remaining trading-day count. Replacing 365 by 252 while leaving “30 calendar days” unchanged mixes clocks. Event variance, changing volatility and skew can defeat constant-volatility scaling.
Only if the stated approximate standardized change really followed a normal model would its ±1-SD interval have approximately 68.27% model mass. IV is inferred from priced risk, not a calibrated real-world frequency promise. Do not convert that conditional mathematical statement into “this stock has a 68.27% chance to stay inside these prices.” No empirical tail frequency is measured by this fictional example.
2. Separate ATM-straddle-price proxy. On the same fictional $400 underlying, $400 strike and 30-day expiry, suppose the call and put are each quoted at $9.15/share. These are chosen illustrative premiums, not observed market quotes or a claim of an exact IV calibration. Cost = 9.15+9.15 = $18.30/share, or $1,830 for one call plus one put each with an unadjusted 100-share multiplier, before costs. Under an intact expiry intrinsic-payoff comparison the long pair’s break-evens are 400±18.30, or $381.70/$418.30. They are payoff break-evens, not one-SD probability boundaries.
Why the different sizes? A straddle pays an absolute move from its strike, whereas SD is a squared-deviation scale. In an ideal zero-mean normal price-change illustration, E|change|=SD×√(2/π)≈0.79788456×SD. Here that is about $18.2997, not $22.9353. This illustrates why different statistics differ even in a simple model; it is not a universal market conversion from straddle premium to SD. Discounting, strike versus forward, skew, distribution and pricing conventions matter.
See Option Premium: Intrinsic Value, Time Value and Moneyness and The Option Greeks in Plain Language: Delta, Gamma, Theta, Vega for the already-developed pricing components and sensitivities, and Straddles and Strangles: Payoffs Built From Volatility for matched expiry payoffs. Do not infer actual option value from a price-move range alone.
Volatility diagram
Read the diagram step by step
- Authored fiction. Education only; not market observations.
- Constant volatility; zero-drift approximate price change.
- 68.27%: CONDITIONAL MODEL MASS
- Only under the stated approximate normal model. NOT MARKET PROBABILITY; not a direction forecast or guaranteed boundary.
- Same fictional S=$400, K=$400 and 30-day expiry. Call $9.15/share + put $9.15/share = $18.30/share; chosen premiums, not observed quotes or an exact IV calibration.
- P/L ($/share); intact intrinsic-payoff comparison
- $381.70 / $418.30 are payoff break-evens before costs, not one-SD probability boundaries. The two panels measure different things.
- Both examples have the same fictional horizon, but measure different things. A symmetric linearized SD band is not a straddle’s break-even range or a forecast. Education only; no forecast.
Illustrative diagram constructed for teaching. Not real market data.
Both examples have the same fictional horizon, but measure different things. A symmetric linearized SD band is not a straddle’s break-even range or a forecast.
What are IV rank, IV percentile and skew?
Is 25% implied volatility high or low?
It depends on the product and its history, so traders compare IV with its own past:
- IV rank places today’s IV within its range over a lookback, often one year: 0 at the low, 100 at the high.
- IV percentile gives the share of days in the lookback when IV was lower than today.
Implied volatility also differs across strikes and expirations. The pattern across strikes is called the skew. For stock indexes, out-of-the-money puts usually carry higher IV than out-of-the-money calls, reflecting demand for downside protection. The pattern across expirations is the term structure. Ahead of a scheduled event such as an earnings report, the expiration just after the event often carries higher IV, and it tends to drop once the event has passed.
What this does not tell you about volatility
- An expected move is a model estimate of size, not a forecast of direction or a boundary price will respect.
- Implied volatility can change quickly, and different platforms calculate it in slightly different ways.
- High or low IV does not by itself make an option a good or bad trade.
- Fat tails, gaps and events can push price far beyond any one-standard-deviation range.
Method in Practice: the expected move as the plan's range
Fictional example. John, Harbor Index futures, the prices, times, costs and results are all invented for teaching. This shows how a written plan can be built and tested. It is not a recommendation, and nothing here says how often this idea works.
Try it on a real chart. Test this idea yourself on past sessions with bar replay. Keep your own count, including the days with no trade.
The idea. An expected move is a model estimate of size, not a boundary price must respect (this lesson). John uses it to check whether his target is realistic for the week. If his target is outside the one-standard-deviation range, he skips the trade.
John's plan (100 shares of the Harbor Index ETF)
- Setup
- ETF $100.00, implied volatility 20%, 5 sessions. Expected move = 100 × 0.20 × √(5 ÷ 252) = $2.82
- Enter if
- the plan's target is inside $100 ± $2.82. Buy at $100.00
- Wrong if
- price trades at $98.80 (stop order)
- Manage
- target $102.00, or exit at the end of the week
- Risk
- $150 maximum, costs included
Three outcomes
-
Worked: target $102.00 inside the range, reached → +$198
-
Failed: the week fell $3.40, beyond the expected move. The stop filled at $98.78 → −$124
-
No trade: a target of $103.50 was outside the range → $0
Show the full replays
| Replay | What happened | Result after costs |
|---|---|---|
| A | Bought 100 at $100.00. Reached $102.00 on day 3 (limit) | +$200 − $2 = +$198 |
| B | Bought at $100.00. Fell to $96.60 by day 4. Stop at $98.80 filled at $98.78 | −$122 − $2 = −$124 (the stop held; the week moved beyond the range) |
| C | Target $103.50, outside $97.18–$102.82 | $0 |
Test it yourself
- Work out the expected move with the calculator, from the same IV source each time.
- Log how often price went beyond the range in your sample. Expect some.
- Compare with targets set without the range check.
Where it breaks
- Gaps and events can push price far beyond any one-standard-deviation range.
- IV changes quickly, and platforms calculate it differently.
- The range says nothing about direction.
Calculators: expected moveposition size
Reflection question: Is any target in your plan bigger than what the options market is pricing?
Check yourself
- Compute the scale for $100, 30% annual IV and 9 calendar days. Hint: √(9 ÷ 365) is about 0.157.
- Why is the example’s $18.30 not automatically its SD?
- Does an observed expiry outside $377.06–$422.94 prove the arithmetic was wrong?
- What distinguishes historical volatility from implied volatility, including where each input comes from? Hint: one is calculated from the past, the other from today’s option prices.
- Why might IV fall just after a scheduled announcement, and why might it not?
Reflect on your own process
- When you write an expected-move figure in your notes, do you also record which statistic, day count and IV source produced it?
- How does your review process treat a result outside a one-standard-deviation band, and what do you record about it?
- Which lookback does your checklist use for IV rank or percentile, and where is that choice written down?
- Is any target in your plan bigger than what the options market is pricing?