# The Volatility Risk Premium

> Options are priced on how much people expect a stock to move. On average, across stocks and across decades, they expect more movement than actually happens.

Canonical: https://spout.finance/docs/volatility-risk-premium/

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Options are priced on how much people expect a stock to move. On average, across stocks and across decades, they expect more movement than actually happens. The gap is the volatility risk premium, and it is what covered call sellers are paid for.

## Two kinds of volatility

|  | Implied volatility | Realized volatility |
| --- | --- | --- |
| What it is | The movement priced into options today | The movement that actually happens |
| Set by | What option buyers are willing to pay | The stock's real price path |
| Known | Now | Only afterwards |

When implied volatility is above realized volatility, option sellers collect more in premium than they pay out on average.

## An analogy: insurance

An insurer charges premiums that, on average, exceed what it pays in claims. That margin is not a trick: buyers pay it gladly for protection. Options work the same way. Many buyers use options as protection, or as a cheap way to bet on a big move, and they pay more than the options turn out to be worth on average.

Like an insurer, an option seller faces occasional large payouts. For a covered call seller, that payout is the part of a sharp rally above the strike. Over many cycles, the aim is for the steady premium to more than cover those occasional costs.

## What it does not mean

The premium is an average, not a guarantee. It is larger in some periods than others, and there can be long stretches where realized movement catches up with implied. Spout's lender targets are illustrations for this reason.