# Tag Info

1

This has been asked many times already. Volatility always refers to a model. And unless stated otherwise this model is the Black-Scholes model. In this model the volatility is the standard deviation of the log-returns divided by the square-root of time:  \log(\frac{S_{t}}{S_0}) = (r - \frac{1}{2}\sigma^2)t + \sigma W_t \sim \mathcal{N}\left( (r - ...

1

Look at the B-S parameters for the dynamics of the stock. $\frac{dS}{S} = \mu dt + \sigma dt$ $\sigma$ is independent of strike in the B-S model, which means all derivatives priced assuming these dynamics should have the same volatility. This clearly is not the case given the existence of smile and skew. You can't assume the BS model produces the "fair" ...

1

One reason is that implied volatility measures the relative value of the option as the price of an option depends on various parameters. As everyone has its own pricing model, it's insane to quote all parameters. This little simple IV tells you everything you'd need to know for valuation.

2

The most common use for implied volatility in valuation is for asseing options or option like postions. A volatile instrument is likley to activate or put an option postion in the money just on the basis of its volatility rather than any fundamental change in the intrinsic or fair market value of the underlying. This needs to be taken into account when ...

1

A pithy way to put it is "implied volatility is the wrong number to put in the wrong formula to get the right price." That is, implied volatility is by definition the parameter $\sigma$ to plug into the Black-Scholes option pricing formula to get the market price of a vanilla option. This is called "volatility," but in reality it isn't the same as the ...

5

No. Implied volatility isn't a historical measure of standard deviation. Implied volatility is used to relate a market price to some model, be that Black-Scholes or something more sophisticated. Another way to phrase it, implied vol is that single vol input into a model, such that the model reproduces the market prices. Different models will have ...

Top 50 recent answers are included