Using Implied Volatility to Guide Retail Energy Hedging Decisions

For retail electricity and natural gas buyers, timing a fixed-price energy contract can feel like a guessing game. Should you lock in now or wait? Are prices likely to spike or stay flat? While commodity traders use a variety of sophisticated tools to make these calls, one of the most insightful indicators that can help retail buyers is something called implied volatility (IV).

What Is Implied Volatility?

Implied volatility is a measure of the market's expectations for how much a commodity's price will move in the future. It's expressed as a percentage and is derived from the prices of financial instruments tied to energy contracts. In simple terms, the higher the implied volatility, the more uncertainty the market sees in future prices. Conversely, a lower implied volatility suggests the market expects relatively stable prices.

Retail buyers don’t need to calculate implied volatility themselves. For electricity and natural gas contracts, IV is typically measured as a percentage for specific delivery periods, such as calendar year 2026 or a winter strip. While this data isn’t widely available to end users, we have access to it and can help our clients leverage it to make more informed decisions.

What Does "ATM" Mean?

ATM stands for at-the-money, which refers to the strike price closest to the current market price of the underlying commodity. When referencing implied volatility, the ATM value reflects the market's view of risk for the most relevant or expected price level. For example, if the market expects power to settle around $60/MWh for a given term, the ATM volatility would be based on contracts with a $60 reference price. For energy buyers, implied volatility based on ATM options is an ideal, time-tested approach for decision-making around when to hedge.

Why Should Retail Buyers Care About IV?

Even if you're not dealing in financial derivatives, implied volatility is a valuable tool for understanding when to hedge. That's because:

• Low implied volatility often coincides with lower forward prices and calmer market sentiment. This makes it an ideal time to lock in a fixed price.
• High implied volatility typically reflects market stress, uncertainty, or risk premiums, which often translates to higher fixed prices.

In other words, IV can help you decide whether the current market offers good value for a hedge.

One noteworthy example is ERCOT (the Texas electricity market), where implied volatilities tend to run significantly higher than in other markets. That’s because ERCOT is more prone to extreme weather, has fewer interconnections to neighboring grids, and relies heavily on wind and solar generation — all of which increase price volatility. As a result, even in relatively quiet times, ERCOT forward prices often carry a higher risk premium.

How to Use IV in Your Hedging Strategy

Here’s a simplified guide to interpreting implied volatility for a specific product and term:

• IV less than 20%: The market expects very little price movement. This is often the best time to lock in a fixed price because there's minimal premium built in.
  
  
• IV between 20% and 35%: This range reflects typical or average risk. It may be a good time to hedge a portion of your volume or monitor market trends closely.
  
  
• IV between 35% and 50%: The market is pricing in elevated uncertainty. You may want to hedge selectively or use a strategy with more flexibility in timing.
  
  
• IV above 50%: This suggests high market stress and very expensive fixed pricing. Unless you have pressing budget constraints, it may make sense to wait for more favorable conditions.

PJM West Hub IV as of 8/11/2025

To apply this, review the at-the-money (ATM) implied volatility for the product and term you are considering. For example, if you are evaluating a fixed-price electric contract for winter 2025, check the ATM implied volatility for that strip. If it is under 20%, the market is signaling that risk is low and the cost to lock in a fixed price is likely more favorable.

Retail energy buyers don’t need to be professional traders to make informed hedging decisions. By incorporating implied volatility into your procurement strategy, you gain insight into when the market is calm and when it's flashing warning signs. While IV doesn’t predict direction, it helps assess how much prices are likely to move, which can guide timing.

Ultimately, hedging when implied volatility is low allows you to lock in budget certainty at a time when the market isn't charging a premium for risk. That’s a smart move for any energy buyer focused on cost stability over speculation.

For additional information please contact us to schedule a quick call.