Define “Implied Volatility” and Its Role in Option Pricing

Implied Volatility (IV) is a forward-looking measure derived from an option's market price, representing the market's expectation of the underlying asset's price fluctuation over the option's life. Unlike historical volatility, IV is not observed directly but is backed out of the Black-Scholes model.

High IV suggests the market anticipates large price swings, leading to higher option premiums.