Implied vs realized volatility: what the gap actually pays

The two numbers

Implied volatility is derived from option prices — it is what buyers and sellers have agreed a stock's future movement is worth. Realized volatility is computed after the fact from the stock's own price history.

Because one is a price and the other is an outcome, they are rarely equal. The persistent gap between them is called the variance risk premium, and it exists because option sellers demand compensation for carrying tail risk.

Implied overshoots — in both directions

The interesting part is not that implied usually exceeds realized. It is that implied over-reacts at both extremes while realized pulls back toward its own average.

Measured across roughly 495 symbols and two years, when options were priced richest relative to a stock's own recent range they charged about 1.45 times that range — and the stock went on to deliver about 1.2 times. When they were cheapest they charged about 0.66 times, and the stock delivered about 0.8.

So the mispricing runs both ways. Rich options are overpriced; cheap options are underpriced. Most commentary only mentions the first half.

Why this is not free money

Three things must be said in the same breath as any premium-selling result, and they usually are not.

First, the effect is market-wide and well documented — selecting the richest names adds to it, but the baseline is not anyone's discovery. Second, short-volatility losses arrive together across names; everything gaps at once, so a good per-trade edge is not a safe portfolio. Third, any study of it that uses a list of companies that still exist has quietly excluded the ones that went to zero, which is precisely when this trade fails.

A strategy with a high win rate and a fat left tail is exactly the shape that looks brilliant for two years.

Using it per symbol

The practical read is comparative, not absolute. Ask what options are charging for a day on this ticker against what this ticker has actually been moving. Rich says selling is favoured; cheap says be picky or take the other side.

FlowMonkey surfaces exactly that on Option Selling as a plain-language read, measured on each symbol's own history rather than a market-wide average.