What Causes Implied Volatility to Change? A Detailed Guide for Traders
Implied Volatility (IV) is one of the most critical factors in options pricing. Unlike historical volatility, which reflects past price movement, implied volatility tells us what the market expects in terms of future price action. But what makes implied volatility go up or down?
In this blog, we’ll explore the key drivers of implied volatility, and how you as a trader or investor can use this knowledge to make informed decisions.
What Is Implied Volatility?
Implied volatility (IV) represents the market’s forecast of a stock or index’s potential price movement in the future. It’s derived from option prices using models like the Black-Scholes, and is not based on actual past movement, but rather on trader expectations.
When IV rises, it usually means the market expects more volatility in the near future. When it falls, the market anticipates calmer conditions.
Top Factors That Influence Implied Volatility
1. Option Demand and Supply Dynamics
Implied volatility is heavily impacted by buying and selling activity in the options market:
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When there is high demand for options, especially for calls or puts ahead of key events, IV increases.
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When demand falls or there is heavy option selling, IV tends to drop.
Example: Before an earnings announcement, traders rush to buy options to hedge or speculate, causing IV to rise.
2. Upcoming Market Events
Major scheduled or unscheduled events can sharply impact implied volatility:
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Earnings reports
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RBI policy announcements
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Union Budgets
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Election results
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Geopolitical tensions or wars
In most cases, IV rises before the event (due to uncertainty), and falls sharply afterward — a phenomenon called “IV Crush.”
3. Realized Volatility and Market Conditions
When actual market volatility (price swings) increases:
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Traders anticipate bigger future moves
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They bid up option premiums
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This leads to a rise in implied volatility
Conversely, in sideways or range-bound markets, IV often remains low.
4. Time to Expiry (Theta Decay Effect)
As options near expiry, their time value erodes (theta decay), and this usually pulls IV lower. However, if an important event is due before expiry, IV can remain high or even increase in the short term.
5. Interest Rates and Dividends
While not major factors, changes in:
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Interest rates
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Dividend expectations
…can subtly impact implied volatility, especially in longer-dated options. These variables affect the Black-Scholes pricing model and thus, IV.
6. Investor Sentiment & Fear Index (VIX)
The India VIX (Volatility Index) is often referred to as the “Fear Gauge”. A rising VIX indicates rising fear and uncertainty in the market:
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When VIX increases → IV across the board tends to rise
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When VIX drops → Market appears calmer, and IV declines
VIX is a good indicator of market-wide implied volatility.
7. Liquidity & Market Maker Activity
In illiquid stocks or less-traded options:
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Wide bid-ask spreads cause IV to fluctuate rapidly
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Market makers adjusting quotes or hedges can cause sudden IV changes
This is why you may see options of the same stock showing different IVs depending on the strike or expiry.
Summary: What Moves Implied Volatility?
| Factor | Effect on IV |
|---|---|
| High demand for options | ⬆️ IV increases |
| Major event approaching | ⬆️ IV increases |
| Event outcome is known | ⬇️ IV falls (IV Crush) |
| High realized (actual) volatility | ⬆️ IV increases |
| Sideways market or calm period | ⬇️ IV decreases |
| Investor fear (VIX rising) | ⬆️ IV increases |
| Low liquidity | IV becomes unstable |
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