What does "implied volatility" indicate in derivatives?

What does "implied volatility" indicate in derivatives?

• A. The actual historical volatility of the underlying asset
• B. The market's expectation of future volatility of the underlying asset
• C. The volatility of an asset based solely on past performance
• D. The volatility derived from the strike price of options

Answer: (B)

Implied volatility reflects the market's expectations about the future volatility of the underlying asset. It is derived from the pricing of options and is an essential concept in derivatives trading. Specifically, it represents how much the market believes the price of the underlying asset will fluctuate over a specified period, which is particularly relevant when assessing options pricing and risk. Implied volatility is often viewed as a critical measure because it helps traders gauge market sentiment and the perceived uncertainty about an asset's price movements. When implied volatility is high, it suggests that the market anticipates significant price swings, while low implied volatility indicates expectations of more stable pricing. In contrast to actual historical volatility, which is based on past price movements, or the volatility that might be inferred from strike prices, implied volatility focuses exclusively on what the market currently expects regarding future variability. This makes it a forward-looking metric, providing insight into how investors are positioned or how they feel about the asset’s future performance.

Implied volatility reflects the market's expectations about the future volatility of the underlying asset. It is derived from the pricing of options and is an essential concept in derivatives trading. Specifically, it represents how much the market believes the price of the underlying asset will fluctuate over a specified period, which is particularly relevant when assessing options pricing and risk.

Implied volatility is often viewed as a critical measure because it helps traders gauge market sentiment and the perceived uncertainty about an asset's price movements. When implied volatility is high, it suggests that the market anticipates significant price swings, while low implied volatility indicates expectations of more stable pricing.

In contrast to actual historical volatility, which is based on past price movements, or the volatility that might be inferred from strike prices, implied volatility focuses exclusively on what the market currently expects regarding future variability. This makes it a forward-looking metric, providing insight into how investors are positioned or how they feel about the asset’s future performance.