Essential Knowledge for Options Trading: What Exactly Does Implied Volatility Do?

Anyone trading options can’t avoid one key term—Implied Volatility (IV). Simply put, it’s the market’s expectation of how much the price will fluctuate in the future.

Don’t Confuse These Two Volatilities

Historical Volatility (HV) = Looks at the past, how much the asset has fluctuated over the last 20 or 60 days

Implied Volatility (IV) = Looks at the future, traders are betting on how the asset will fluctuate next

Simple comparison: HV is the rearview mirror, IV is the crystal ball. Both are expressed as annualized percentages.

How IV Affects Option Prices

Option Price = Intrinsic Value + Time Value

Only the time value is affected by IV. The higher the IV, the more expensive the option; the lower the IV, the cheaper the option.

Measured by Vega (one of the Greek letters): For every 1% change in IV, the option price moves by a certain amount.

Small Example

You buy a Bitcoin call option:

• Current price: 20000 USDT
• Strike price: 25000 USDT

You (the buyer) want: The more the price swings, the better—the higher the chance it hits 25000.

The seller’s position is the opposite: Hoping the price stays still.

→ So the more volatile it is, the higher the IV, the more expensive the option premium.

IV + Time to Expiry = ?

Options with more time left: IV has a stronger impact (more uncertainty)

Near-expiry options: IV has a weaker impact (almost settled)

The More Extreme the Strike, the Wilder the IV

The IV curve for options usually forms a U-shape (called a “volatility smile”):

• Strike price = Spot price, IV is lowest
• The further the strike price from spot, the higher the IV

Why? Two reasons:

1. Higher probability of extreme events: The market tends to overestimate the chance of sharp price moves
2. Hedging costs: If out-of-the-money (OTM) options suddenly become in the money, the seller’s risk skyrockets, so they raise the price for compensation

How to Judge If IV Is Overvalued or Undervalued

IV > HV (Overvalued) → Options are too expensive

• Strategy: Sell volatility (short options), such as the “Iron Condor” strategy

IV < HV (Undervalued) → Options are underpriced

• Strategy: Buy volatility (long options), such as the “Long Straddle” strategy

Judging Logic

Compare long-term HV and short-term HV:

If the IV of at-the-money (ATM) options is higher than both HVs → Clearly overpriced

If IV is much lower than long-term HV → Time to bargain hunt

How to Trade with IV

Choose an IV-based order mode to quote directly by volatility.

Note: Your order price will follow changes in the underlying asset price and time decay in real-time—this is the principle of dynamic hedging.

Core logic: IV doesn’t appear out of nowhere; it’s the result of market competition. Learn to benchmark against HV to judge if it’s high or low, so you can go against the crowd when others are FOMO-ing.