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Volatility can be measured in a number of different ways, but for investors in the options market, none of the measures are more important than implied volatility [IV]. It not only tells how much an investment is expected to move, but also whether an options contract is cheap or expensive.

Volatility is term that simply means the speed of movement of an investment. Some, like bonds, tend to move more slowly and have low levels of volatility. Others, like some of the low-priced banks and autos in early 2009, move fast and have high levels of volatility. Because the options market is relatively efficient, the options prices or premiums normally reflect the volatility of the underlying asset. For example, prices of SPDR Gold Trust (GLD) options reflect the volatility associated with GLD options and options on BofA (BAC) have premiums that correspond to BACs volatility. All else being equal, the asset with higher volatility will have higher premiums than the one with low volatility. Why? Consider this: if two stocks are both trading for $20 and one (Stock A) has been in a $21 to $23 range over the past six months, while the other (Stock B) has traded in a $10 to $40 range, which one is more likely to trade above $25 over the next six months? Probably the more volatile one, or Stock B. Therefore, a call option with a $25 strike will be worth more on the higher volatility stock, or Stock B. That $25 call is more likely to be in-the-money at expiration compared to Stock A, which has been in trading in a narrow $2 range below $25.

Implied volatility is the mathematical measure that quantifies the level of volatility in a given options contract. Computed using an options-pricing model (but also widely available on a number of options-related web sites like here ), it is computed as a percentage. Importantly, not only does each options contract have a unique level of implied volatility, but it is always changing. In addition, since the options market is efficient, IV will often change to reflect expectations about future volatility of an investment. For example, implied volatility will often move higher before an earnings report, which can cause a big move in shares of the company. Then, once the event has passed, implied volatility will often fall.