Explain the Concept of Implied Volatility in Options Trading and Its Use in Financial Derivatives

Implied volatility (IV) is the market's expectation of how volatile an underlying asset's price will be over the life of the option contract. It is derived by working backward from the current market price of an option using a pricing model like Black-Scholes.

Arbitrageurs compare the IV of different options or compare IV to historical volatility to identify mispriced derivatives. High IV suggests the market anticipates large price swings.