Option Volatility:

 Volatility is simply a measure of the rate and

magnitude of the change of prices (both up and down)
of the underlying.
 When volatility is high, the premium on an option will
also be relatively high.
 If you’re considering different options strategies,
knowing whether or not those options are “expensive”
or “inexpensive” can be very useful in making a
determination about whether to sell or buy. Of course,
the old adage dictating that investors should buy low
and sell high applies in options trading as much as it
does in any other type of investing or trading.
Historical Volatility
 Historical volatility is a quantifiable number which is
based on past changes to the price of a stock or futures
contract.
 Higher the level of historical volatility, the more that
the stock has moved in recent history.
 It’s important to remember that historical volatility
does not provide insight into either trend or direction.
Calculation
 Calculate the average
 Calculate the deviation – Subtract the average from the
actual observation
 Square and add up all deviations – this is called
variance
 Calculate the square root of variance – this is called
standard deviation
 Percent
Closing Price Change Deviation Diviation Square
558.75
570.9 2.1745 2.28782 5.2340989
576.85 1.04221 1.15553 1.3352559
551.05 -4.4726 -4.3592 19.003042
557.05 1.08883 1.20215 1.4451624
550.75 -1.131 -1.0176 1.0355892
544.4 -1.153 -1.0397 1.0808816
536 -1.543 -1.4297 2.0439404
548.65 2.36007 2.47339 6.1176744
549.55 0.16404 0.27736 0.0769273
551.4 0.33664 0.44996 0.202462
 Mean= Sum of percent change/10
 Standard Deviation=
Exponentially weighted moving
average (EWMA)
 To convert daily volatility to annual volatility multiply
the daily volatility by the square root of time
Implied Volatility
 Implied volatility is the estimated volatility
 Factors: Supply and demand is a major determining
factor for implied volatility. When a security is in high
demand, the price tends to rise, and so does implied
volatility, which leads to a higher option premium due
to the risky nature of the option.
 Time value of the option.
Volatility Smile
 A volatility smile is a geographical pattern of implied
volatility for a series of options that has the same
expiration date.
 The volatility smile's existence shows that OTM and
ITM options tend to be more in demand than ATM
options.
 Extreme events can occur causing significant price
shifts in options.
Term Structure
 The term structure shows how the maturity date of an
option will change the implied volatility over time.
 The term structure of implied volatility describes the
pattern of options with the same strike price but
different maturities.