How Does the Black-Scholes Model Use Implied Volatility?

The Black-Scholes model is a mathematical formula used to estimate the theoretical price of European-style options. It requires five inputs: the underlying asset's price, the strike price, the time to expiration, the risk-free interest rate, and volatility.

Since volatility is not directly observable, the model is often run in reverse, using the option's current market price to calculate the implied volatility (IV). IV is then used to price other options, making it the most critical and dynamic input.