Implied and Realised Volatility

The 7:42 to Dadar

The announcement board flickered red for the third time: "Severe disruption expected on Down Line. Passengers advised to prepare for extended delays."

Rohan felt his shoulders drop. He had exactly forty minutes to reach Dadar for a client call he couldn't reschedule.

Around him, the platform reacted like one nervous organism. A man in a grey office shirt started calling his wife to say he'd be late for dinner. Two college students abandoned their spot near the yellow line and sat down on their bags, resigned. An uncle near the tea stall muttered, "Signal fail, hai na. Ho jayega ek ghanta late."

Kavya, waiting beside Rohan with her earphones half in, raised an eyebrow at the crowd's sudden gloom. "Everyone's already living the delay," she said, "and the train hasn't even shown up yet."

Rohan didn't laugh. He was busy mentally rearranging his evening — skip the call, message his manager, maybe leave the report for tomorrow. The board had said "severe." That word had already rearranged his whole night.

Twelve minutes later, a horn sounded. The 7:42 rolled in — six minutes behind schedule, doors opening smoothly, not a single visible sign of the "severe disruption" anyone had braced for.

The office-shirt man got on, still holding his phone, looking faintly confused, as if he owed his wife an apology for the apology he'd already made.

Rohan stood on the platform a second longer than he needed to, staring at the train that had arrived almost normally.

"That's it?" he said. "Six minutes. They said severe."

Kavya shrugged, stepping in behind him. "It probably was going to be severe. Something must have looked bad when they made the announcement — a signal issue, a stalled train ahead, who knows. They warned based on what they saw then. What actually happened is a separate thing that got decided later."

Rohan turned that over in his head as the train pulled away from the platform, gathering speed toward Dadar, ordinary and unremarkable.

He didn't have a word for it yet. But something about the gap between the warning and the six-minute delay stayed with him longer than the delay itself ever could have.

• Explain what implied volatility represents and how it reflects the market's forward-looking expectation of price movement.
• Explain what realised volatility represents as a backward-looking measure of price movement that has already happened.
• Recognise that a gap between implied and realised volatility is normal, and use that gap to judge how much confidence to place in a quoted volatility figure rather than treating it as a prediction.

Every time you look at an option chain, you'll see a volatility number sitting next to a stock or index. That number matters because it tells you how much the market is bracing for movement — but only if you know exactly what kind of number you're looking at.

There are two completely different measures hiding under the one word "volatility," and mixing them up is exactly what happened to Rohan on the platform.

The first is Implied Volatility (IV) — the market's current, forward-looking guess about how much a stock might move before the option expires. It isn't a fact. It's a collective opinion, priced in by thousands of traders buying and selling options right now, based on whatever they know today. Just like the station announcement, IV is a warning issued under uncertainty — it reflects fear, confidence, and demand at this moment, not a promise about tomorrow.

The gap between them isn't a mistake to fix — it's a normal feature of markets.

The second is Realised Volatility (RV) — the backward-looking, measured record of how much the price actually moved over a period that has already passed. RV is calm and settled, like the train that actually pulled in six minutes late. It's history. It happened, it's done, and it can be measured exactly.

Because IV is a guess about the future and RV is a record of the past, they will almost never line up exactly.

That's the turn worth sitting with: the gap between them isn't a mistake to fix — it's a permanent, normal feature of markets. A high IV doesn't guarantee a big move any more than "severe disruption expected" guaranteed a chaotic delay. And a calm RV doesn't guarantee the next period will stay calm either — past movement is not a forecast for future movement.

So the useful habit isn't trying to predict which number will "win." It's noticing which number you're even looking at — expectation or outcome — before you let it change your decisions.

That evening, once he'd made it to Dadar, Rohan opened his trading app while waiting for his meeting to start. He pulled up the option chain for a stock he'd been tracking.

Two numbers sat side by side. Implied volatility: 35%. Realised volatility (past month): 18%.

His first instinct was the same one he'd had on the platform — he read the bigger number as a promise. "35% IV," he thought. "That's almost double what actually happened last month. A big move must be coming."

Then he paused, remembering the announcement board, the crowd bracing for chaos, and the train that arrived six minutes late.

He looked again. The 35% wasn't a fact about the future — it was the market's current guess, priced into the options right now, based on whatever traders knew today. It could turn out too high, too low, or roughly right; nobody would know until later. The 18% wasn't a warning at all — it was simply what had already happened over the last month, settled and unchangeable.

Rohan sat back. Neither number was promising him anything. The 35% was today's expectation. The 18% was last month's outcome. He closed the option chain, made a mental note — "expectation, not outcome" — and went in to take his call.

Point: The same 'expectation vs reality' gap Rohan felt at the station shows up numerically on an option chain: IV is the forward guess, RV is the settled past, and neither guarantees the other.

One more thing worth knowing, without going into how it's calculated: when IV rises, option premiums usually get more expensive. That's because option sellers are pricing in more uncertainty, and uncertainty has a cost — the more movement that's plausible, the more someone will charge you for the right to bet on it. This doesn't mean the price is "correct" or that the move will actually happen at that size. It just means more uncertainty is currently baked into the price. How that price is precisely calculated, and how RV is measured from historical data, belongs to a later unit — here, it's enough to know that IV going up makes options cost more, simply because more uncertainty is being priced in.

• Assuming high implied volatility means a big price move is definitely coming. — News and apps flash 'high IV' with dramatic language, so it's easy to mistake a priced-in expectation for a guaranteed forecast. Fix: Remind yourself IV only means the market is currently pricing in more uncertainty and is willing to pay more for that possibility — the real move (realised volatility) can end up smaller or larger than expected.
• Trusting realised volatility to reliably predict what will happen next. — RV feels more trustworthy because it's a real, measured number, unlike IV's 'guess' — so it seems like solid ground for a prediction. Fix: Treat RV as history only. It tells you what already happened, not what's coming — use it as one input, never as a prophecy.
• Believing that a gap between IV and RV signals a market error or an easy opportunity to exploit. — It feels intuitively fair that expectation and outcome should line up, so any mismatch feels like something is 'wrong' that can be traded on. Fix: Recognise the gap as a permanent, normal feature of markets under uncertainty — not a flaw to fix or a simple signal to act on.

• Implied volatility (IV) is the market's current, forward-looking guess about future price movement, priced into options.
• Realised volatility (RV) is the backward-looking, measured record of how much a price actually moved in the past.
• IV and RV almost never match exactly — and that gap is normal, not a mistake to fix or predict.
• Before trusting any volatility number, ask: is this telling me an expectation, or an outcome?
• High IV never guarantees a big move, and calm RV never guarantees a calm future.

Q1. What does Implied Volatility (IV) actually represent?

• The market's current, forward-looking guess about how much a stock might move, priced into options
• The exact percentage a stock will move before expiry
• The measured record of how much a stock moved last month
• A guarantee set by SEBI on option pricing Answer: The market's current, forward-looking guess about how much a stock might move, priced into options — IV is a forward-looking number set collectively by traders based on today's information — it's an expectation, not a fact about what will happen.

Q2. Realised Volatility (RV) is best described as which of these?

• A backward-looking, measured record of how much price actually moved in the past
• A forward-looking prediction of future price moves
• The price a trader pays for an option
• A crowd's guess about upcoming uncertainty Answer: A backward-looking, measured record of how much price actually moved in the past — RV is history — it tells you what already happened over a past period, not what is coming next.

Q3. True or False: If implied volatility is much higher than realised volatility, it means the market made an error that is guaranteed to correct itself with a big price move. Answer: False — A gap between IV and RV is a normal, permanent feature of markets under uncertainty — it is not proof of an error and does not guarantee any particular future move.

Q4. Priya reads a news headline: "Volatility spikes to 40% ahead of company results — brace for a huge swing!" Based on what you've learned, what is the wisest first question for Priya to ask before reacting?

• Is this 40% describing what the market currently expects, or what has already happened?
• Is 40% higher or lower than 100%?
• Which broker published this headline?
• Should I buy options immediately before the price moves? Answer: Is this 40% describing what the market currently expects, or what has already happened? — Before trusting any volatility figure, the wise habit is to check whether it's an expectation (IV) or an outcome (RV) — that decides how much weight to give it, rather than reacting to the number itself.

Q5. IV on a stock is 45%, its RV last month was 15%. A trader says: "This gap proves the stock is about to crash." Does a large IV-RV gap prove a crash is coming? Reveal: Weak: yes, such a big gap must mean something dramatic is coming. Strong: IV and RV are separate measures, one forward-looking, one backward-looking — a gap between them is normal and doesn't predict direction; it just means the market currently expects more movement than recently happened.