Implied Volatility and the Expected Move

Step 2 of 3 in Options Essentials.

Implied volatility is the only input to an option's price that cannot be observed. Spot, strike, time and rates are all facts; volatility is the market's forecast. Read correctly, an IV number tells you precisely how far the market expects a stock to travel — which is the single most useful thing an option chain will tell you.

What the number actually says

IV is quoted as an annualised one-standard-deviation move, as a percentage of the stock price.

An IV of 20% on a $100 stock means: over one year, the market expects the stock to finish within ±$20 of where it started, roughly 68% of the time. Within ±$40 (two standard deviations) about 95% of the time.

Two things to hold onto. It is annualised even for a 3-day option, so it always needs scaling down. And 68% is a probability band, not a forecast of direction — IV says nothing about which way.

Scaling it to your timeframe

Expected move = spot × IV × √(days ÷ 365)

The square root is the important part: volatility scales with the square root of time, not linearly. Four times the days is twice the expected move.

Our $100 stock at 20% IV:

Thirty days at 20% IV is a ±5.73% move. Double IV to 40% and the 30-day move doubles to ±$11.47 — vega is linear in IV even though time is not.

The straddle cross-check

There is a second route to the same number that requires no model at all: the price of the at-the-money straddle (the call plus the put at the same strike and expiry).

For our reference position, the 30-day $100 call is worth $2.49 and the put $2.08 — a straddle of $4.58, or 4.58% of spot.

Compare that to the formula's ±$5.73. The straddle sits a little below, consistently and for a reason: the straddle prices the average absolute move (roughly 0.8 standard deviations), while the formula gives one full standard deviation. The common trader's shortcut — straddle price ≈ expected move — is a reasonable approximation that runs about 20% low.

Use both. If the straddle and the IV-derived move disagree by much more than that, check your inputs: usually the days-to-expiry, or an IV taken from a different strike than the one you are pricing.

Using it

Setting strikes that reflect probability. Selling a put outside the expected move means selling something the market prices as unlikely — a 95-strike put on our stock sits outside the 30-day ±$5.73 band. Its delta and the expected move are two views of the same information.

Judging whether options are expensive. IV is only meaningful against its own history. A 30% IV is cheap on a stock that usually runs 45% and dear on one that usually runs 20%. Compare current IV to its 52-week range (IV rank) before deciding anything is over- or under-priced.

Anticipating earnings crush. IV rises into an announcement and collapses after it, often by half. The expected move widens accordingly, and the option price contains that widening. Buying premium into earnings requires the stock to exceed the expected move — being merely right about direction usually loses money.

Sanity-checking targets. If a setup needs a 12% move in three weeks and the 21-day expected move is 5%, the trade is asking for something the market prices at roughly a two-standard-deviation event. That may still be the right trade, but it should be a deliberate choice.

What it does not tell you

• Direction. The band is symmetric. IV rising means a larger expected move, not a fall.
• A guarantee. One standard deviation is a 68% band, so the stock finishes outside it about a third of the time. That is normal, not a model failure.
• Anything about the path. A stock can finish inside the 30-day range having doubled and halved along the way. For anything with a stop or a knockout, the path matters more than the endpoint.
• A distribution that is actually normal. The formula assumes lognormal returns; real markets have fat tails and a volatility skew that prices downside puts above equivalent upside calls. Treat the expected move as a well-calibrated estimate, not as truth.