What Is “Implied Volatility” and Why Is It Important for Option Pricing?

Implied volatility (IV) is the market's estimate of the future volatility of the underlying asset. It is not directly observed but is derived by inputting the current option price into an option pricing model, like Black-Scholes.

IV is crucial because it is the primary driver of an option's premium (time value). Higher IV leads to higher premiums, reflecting greater uncertainty and risk in the market.