Options Article

Why do Traders Care About Implied Volatility Rather Than Historical Volatility?

Last Updated: September 30, 2020

Article Summary

Options traders focus on implied volatility, as it is a measure of the expected changes in the value of an underlying stock and as a barometer of options prices. This is in contrast to historical volatility, which tracks past trading ranges of the stock. Both implied and historical volatility, however, are important determinants on the premium pricing of an options contract.

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Why do Traders Care About Implied Volatility Rather Than Historical Volatility?

Traders don’t necessarily care more about implied volatility versus historical volatility, per se. What traders care about is how volatility, especially where such volatility drives expectations on how large the underlying price movement might be and how such movements, will affect premiums.

High Volatility vs. Low Volatility

High volatility is indicative of shorting (selling) options while low volatility is a buying signal. Implied volatility tends to move in waves of high volatility followed by low volatility, usually finding its way back to the average volatility. Being able to accurately gauge volatility (to the best of one’s ability) helps improve the chances that an options setup will become profitable. This is why many traders use Implied Volatility Rank or Percentile as a measure of where implied volatility currently sits and where opportunity lies. As such, this is one of the most popular criteria that we see our users add to their options trading strategy trees.

Consider this, historical (statistical) volatility looks at trends in the past for how a volatile a stock’s price was, creating a baseline expectation. When compared to current volatility, any anomaly in Historical Volatility (deviation from the norm if you will) may also be used as an indicator of buying or selling opportunities. But that is a reliance on past performance, which we all know is not necessarily indicative of future results.

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