Why is implied volatility higher than realized volatility?

Implied volatility is typically priced higher than realized volatility because of those same dynamic hedging transaction costs and gap risk; the market takes these costs into account and prices IV higher.

What causes changes in implied volatility?

Implied volatility is directly influenced by the supply and demand of the underlying options and by the market’s expectation of the share price’s direction. As expectations rise, or as the demand for an option increases, implied volatility will rise.

How do you trade realized volatility?

To engage in volatility arbitrage, a trader must first forecast the underlying’s future realized volatility. This is typically done by computing the historical daily returns for the underlying for a given past sample such as 252 days (the typical number of trading days in a year for the US stock market).

Do you want a high or low implied volatility?

Implied volatility shows the market’s opinion of the stock’s potential moves, but it doesn’t forecast direction. If the implied volatility is high, the market thinks the stock has potential for large price swings in either direction, just as low IV implies the stock will not move as much by option expiration.

Is implied volatility the standard deviation?

Implied volatility refers to the one standard deviation range of expected movement of a product’s price over the course of a year. If a $100 stock has a 20\% implied volatility, the one standard deviation range of price outcomes would be between $80 and $120 for the year.

Why do investors prefer to use standard deviation as a measure of volatility instead of variance?

Standard deviation helps determine market volatility or the spread of asset prices from their average price. When prices move wildly, standard deviation is high, meaning an investment will be risky. Low standard deviation means prices are calm, so investments come with low risk.