Implied vs Realized Vol

Vega told us an option reacts to how jumpy the market is expected to be. But "expected" is doing a lot of work in that sentence. There are really two kinds of volatility hiding inside it — one the market guesses in advance, and one that only shows up after the fact. Telling them apart is what this lesson is for.

Volatility just means how much something moves. Not which direction — only the size of the swings. A market that drifts in a tight range is low volatility; one that lurches around is high volatility, whether it's lurching up or down.

Realized volatility: what actually happened

Realized volatility (RV) — sometimes called historical volatility — is the backward-looking kind. You take the price moves that have already happened over some window and measure how big they were on average. It's a fact about the past, computed from data that already exists.

Think of it like measuring how bumpy a road was after you've driven it. There's no guessing involved — you simply look at where the price went and add up the size of the wiggles. Different windows give different numbers: the realized vol of the last 5 days can look nothing like the last 30.

Implied volatility: what the market expects

Implied volatility (IV) is the forward-looking kind, and it's a stranger idea. You can't observe future volatility directly — it hasn't happened yet. But you can observe option prices. And an option's price already contains the market's collective guess about how much the underlying will move before expiry.

Run that logic backwards: take the price people are actually paying for an option, ask "what level of future movement would justify this price?", and the answer is the implied volatility. It's the expectation the market has implied through what it's willing to pay.

This is exactly the "expected swinginess" that vega reacts to in the last lesson. When traders brace for bigger moves, they bid options up, and IV rises — even if the underlying hasn't budged yet.

The gap between them

Here's where it gets interesting. IV and RV rarely agree, and the gap between them is information in itself.

When implied volatility sits above realized, the market is paying up for more movement than has actually been occurring — bracing for something, or simply demanding a cushion for the risk of being the seller. When implied sits below realized, options look cheap relative to how much the market has really been moving.

That persistent tendency for implied to run a little richer than realized has a name — the volatility risk premium — and it's part of why option selling exists as a strategy at all. The seller is, on average, collecting that premium for carrying the open-ended obligation we met in lesson one.

Hover to read both lines. The amber band is the premium — implied sitting richer than realized. Where realized spikes above implied, the gap inverts.

Realized — what happened

Start with realized vol: a measured fact about how much the underlying actually moved. No guessing — just the size of the wiggles that already occurred.

Implied — what's expected

Now lay implied vol on top — the movement the market is pricing in, read out of option prices. It usually sits a little above realized.

The premium

That standing gap is the volatility risk premium— sellers charging a cushion for movement that hasn't happened yet.

When it inverts

Sometimes realized spikes above implied. Now options look cheap relative to how much the market has really been moving — a reading, never a signal.

Why this matters for the terminal

The terminal cares about IV for two reasons. First, IV is what turns a wall of option prices into the Greeks — every gamma and vega figure you'll see is computed through an implied volatility. Second, IV isn't one number: it differs by strike and by expiry, and that shape carries its own information about where the market expects movement to concentrate.

Hold on to one thing as we move on: option prices, and the implied volatility inside them, are set by people who must trade — the dealers on the other side of every contract. That's who we meet next.

Example snapshot

What to carry forward

• Volatility = the size of price swings, not their direction.
• Realized volatility (RV) = how much the underlying actually moved — backward-looking, measured from history.
• Implied volatility (IV) = how much the market expects it to move — forward-looking, read out of option prices.
• The gap between them is context: implied often runs richer than realized (the volatility risk premium), but that's a reading, never a signal.
• Every Greek in the terminal is computed through an implied volatility.

Next: the dealers who set these prices — who they are, and why a moving market forces them to trade.

Next step

Compare implied to realized.

The volatility page tracks the implied curve against what the tape has actually delivered.

See live volatility →