Options trading is a complex world where pricing plays a pivotal role in determining the attractiveness of a trade. Option prices are not arbitrary; they are determined by a combination of factors, primarily supply and demand. When entering a trade, investors encounter bid and ask prices, which reflect the willingness of buyers and sellers to consummate a trade. This article delves into the dynamics of option pricing, focusing on the concepts of implied and historical volatility, which significantly impact the options market.

Implied Volatility:

Implied volatility is a vital concept in the world of options trading. It represents the market’s current expectations regarding future price volatility. Implied volatility is not based on past price movements but rather reflects the marketplace’s perception of how much the underlying asset will fluctuate in the future. It plays a crucial role in option pricing models, helping traders evaluate the fairness of an option’s current market price.

To calculate implied volatility for a specific option, you need a computer and the following variables: A. The current price of the underlying security B. The option’s strike price C. Current interest rates D. The number of days until the option expires E. The option’s current market price

With these variables, you can use an option pricing model to solve for implied volatility. For example, if an option is trading at $6.88, you can use these variables to calculate that the implied volatility is 56.20. This means that the market expects the underlying asset to fluctuate significantly based on the option’s current price.

Historical Volatility:

Historical volatility, on the other hand, is a measure of past price fluctuations in the underlying asset. It is calculated by analyzing the standard deviation of price changes over a specific period, such as the last 20 days. Historical volatility provides insight into how the underlying asset has behaved in the past and is often used as a basis for estimating future price movements.

Historical volatility is a useful tool for traders looking to gauge the potential price range of an asset. For example, if a stock has a historical volatility of 30%, it implies that the stock is likely to move up or down by around 30% within the next 12 months. By understanding historical volatility, traders can assess whether an option’s implied volatility is high or low compared to its historical values, helping them make more informed decisions.

The Interplay Between Implied and Historical Volatility:

Traders often compare implied and historical volatility to identify opportunities in the options market. When implied volatility is significantly higher than historical volatility, it may suggest that options are overpriced. Conversely, when implied volatility is lower than historical volatility, options may be considered undervalued.

Successful options traders use this comparison to buy options when implied volatility is low (anticipating future price fluctuations) and sell options when implied volatility is high (betting that the market is overestimating future volatility).


Understanding implied and historical volatility is essential for any options trader. Implied volatility reflects the market’s expectations, while historical volatility provides insight into an asset’s past behavior. By comparing the two, traders can identify opportunities and make more informed decisions when navigating the complex world of options trading. Volatility plays a significant role in option pricing, and recognizing these patterns can give traders an edge in the market.