Realized vs. Implied Volatility: The Options Pricing Gap

The Volatility Risk Premium

The core engine of options pricing revolves around the battle between two metrics: Implied Volatility (IV) and Realized Volatility (RV) (also known as Historical Volatility).

What is Realized Volatility?

Realized Volatility measures what actually happened. It looks backward. If the SPX moved 1% every day for the last week, its realized volatility was high.

What is Implied Volatility?

Implied Volatility measures what the market expects will happen. It looks forward. It is reverse-engineered from current option prices.

The Trade-Off

Most of the time, the market overestimates risk. Therefore, Implied Volatility is usually slightly higher than Realized Volatility. This difference is known as the Volatility Risk Premium (VRP). Option sellers rely on this premium to remain profitable over the long term, as the market usually moves less than the options priced in.

However, during unexpected market shocks, Realized Volatility explodes past Implied Volatility. In these rare “black swan” or gamma squeeze events, 0DTE option buyers can see massive returns, because the options were priced for a quiet day but experienced a violent move instead.

Trading 0DTEs effectively means deciding whether today’s actual market movement (RV) will exceed the movement the market makers priced in (IV) at the morning bell.