Implied volatility of an option contract is the volatility implied by the price of the option based on an option pricing model. In other words, it is the volatility that, given a particular pricing model, yields a theoretical value for the option equal to the current market price.

Implied volatility of an option is a more useful measure of the option's relative value than its price. This is because the price of an option depends most directly on the price of its underlying security.

A call option is trading at Rs. 1.50 with the underlying stock trading at Rs. 42. The implied volatility of the option is determined to be 18.0%. A short time later, the option is trading at Rs. 2 with the underlying stock trading at Rs. 43.5, yielding an implied volatility of 17.2%. Even though the option's price has increased it is still considered cheaper on a volatility basis. This is because the underlying stock needed to hedge the call option can be sold for a higher price.