Implied Volatility Mean Reversion

Implied volatility mean reversion is the tendency of the volatility priced into options to return to its long-term historical average over time. Options prices are heavily influenced by the market expectation of future volatility, known as implied volatility.

When implied volatility spikes due to a sudden market event or panic, it often reaches unsustainable levels that eventually decline as the market stabilizes. Traders employ this strategy by selling expensive options when implied volatility is abnormally high, anticipating a drop back toward the mean.

This strategy is distinct from price mean reversion as it focuses on the cost of protection rather than the asset price itself. It is a cornerstone of volatility trading and requires an understanding of how market participants price risk.

Successful execution depends on the accurate estimation of the mean volatility level.