Implied volatility

The volatility that makes an option pricing model reproduce an option's market price. An output of prices rather than an input, it is how traders quote and compare options across strikes and maturities.

Where you will meet it

Implied volatility appears in 8 learning outcomes on the CFA syllabus. A few of them:

• Show how exposure measures for equities, fixed income, and options can help gauge and control market risk and volatility risk
  CFA Level II · Portfolio Construction

  “For options, delta is the value change per unit move in the underlying, gamma the change in delta, and vega the value change per point of implied volatility, so ΔV ≈ delta × ΔS + ½ × gamma × (ΔS)² + vega × Δσ.”

• Say what implied volatility is and how options traders use it
  CFA Level II · Derivatives and Risk Management

  “Implied volatility is the volatility that makes the option model reproduce the market price.”

• Build a positioning strategy around an expected rise or fall in interest rate volatility
  CFA Level III · Portfolio Management Pathway

  “If the manager expects realised volatility to exceed the implied volatility priced into options, adding convexity pays: buy options such as calls on bond futures or swaptions, or prefer option-free bonds and barbells to callable bonds and mortgage-backed securities, which are short volatility.”

• Explain what calendar spreads are used for
  CFA Level III · Derivatives and Risk Management

  “Being net long vega, it also gains if implied volatility rises.”

Practise it

• Today's practice question One question, with every wrong option explained.
• Free Level I diagnostic test Twelve questions that show which topics to start with.
• Free finance calculators Check your arithmetic on the exam's core formulas.

All terms beginning with I · Glossary