Implied vs realized volatility
What options charge versus what the market does — and why the gap is the whole game.
Implied volatility is the movement options are charging for. Realized volatility is the movement the underlying actually delivered. Every option position, however it is dressed, is ultimately a bet on the gap between them — and the gap is measurable, which makes it one of the few honest edges in the business.
Two numbers, one comparison
Realized vol is computed from returns — how much the thing actually moved, annualised so it lands on the same scale as the implied number quoted in every chain. When implied sits above realized, options are rich: sellers are being paid more than recent movement justifies. When realized runs above implied, options were cheap, and whoever owned them got paid.
Most of the time implied sits modestly above realized. That premium is real — it is what option sellers earn for wearing the tail risk — and its size, not its existence, is the signal. Measured formally, it is the variance risk premium of Bakshi and Kapadia (2003) and Carr and Wu (2009), and it has persisted across decades of data.
Drift: watching the gap live
The terminal’s volatility view tracks the gap through the session. Realized climbing through implied means the market is out-delivering its own pricing — long-premium ideas stop being expensive, and the vol market usually re-marks within hours. Implied stretching far above a sleepy realized means the crowd is paying up for protection that recent movement does not justify.
How this touches everything else
- Gamma regimes: dealers’ hedging pressure scales with how wrong implied is — quiet tape under rich implieds intensifies the pin.
- Event days: implied is priced for the event, realized happens after it. The collapse between them is a flow of its own.
- Position choice: the same directional idea should be expressed with options when they are cheap against realized, and with stock when they are not.
Sources and further reading
The research this guide leans on. Citations rather than links, so they stay verifiable after journal URLs move.
- Bakshi, G. and Kapadia, N. (2003). Delta-Hedged Gains and the Negative Market Volatility Risk Premium. Review of Financial Studies 16(2).
- Carr, P. and Wu, L. (2009). Variance Risk Premiums. Review of Financial Studies 22(3).
- Andersen, T.G., Bollerslev, T., Diebold, F.X. and Labys, P. (2003). Modeling and Forecasting Realized Volatility. Econometrica 71(2).
- Parkinson, M. (1980). The Extreme Value Method for Estimating the Variance of the Rate of Return. Journal of Business 53(1).