# Implied volatility



## malachii (10 March 2005)

I dont know if I'm asking this the right way but I've seen several mentions of IV.  Could someone give me an explaination of how this is calculated, how it is used propertly, what is an acceptable IV and maybe an example????

Malachii


----------



## wayneL (10 March 2005)

malachii said:
			
		

> I dont know if I'm asking this the right way but I've seen several mentions of IV.  Could someone give me an explaination of how this is calculated, how it is used propertly, what is an acceptable IV and maybe an example????
> 
> Malachii




Lets see if I can do this without confusing the issue :-o

First, a definition of historical volatility:
The relative rate at which the price of a security moves up and down. Volatility is found by calculating the annualized standard deviation of daily change in price. If the price of a stock moves up and down rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility. 

If someone sells you an option, that person is taking on risk that the option will expire in the money, incurring a loss for the option seller.

If a stock is not volatile at all, the option seller carries little risk that it will expire in the money, so he is able to sell it reasonably cheaply.

However if a stock is going all over the place, the option seller carries considerably more risk as there is a/ more chance it will expire in the money and b/ could go much further into the money than a non-volatile stock. So he must charge more premium in order to justify that risk.

This is how volatility is priced into the option.

"Implied" volatilty is calculated from the actual price of the option and can be viewed as a measure of the perception of future volatility. This is expressed as a percentage.

So lets take a stock that has a historical (actual) volatility of 15%. If there is an announcement due which could send the the price flying either up or down, the option will have high implied volatilty. In other words the  option will be a lot more expensive because option seller could be exposing himself to much higher risk.

Lets take an at the money $30 call option with 30 days to run. At an implied volatility of 15% it will cost roughly $0.60

However at an implied volatilty of 75% that same option will cost about $2.60.

Thats the basics, I'll let someone else go into how its used, I'm off to my crypt.

Cheers


----------



## money tree (10 March 2005)

thats the basics he says, lol

it is quite a complex issue, and waynes explanation is good.

all I would add is that a high IV makes the option 'expensive'. I remember few years ago when most options had an IV around 20-25. Today a lot have an IV between 12 and 20. So you could say options are 'cheaper. The highest IV I ever saw (and promptly shorted  : ) was when BIL shat itself and dropped 35% in a day. IV at that point was around 85. You guessed it, 85 is super expensive and there really is no way someone buying those options can reasonably expect to make money, simply because there is sooooo much time premium built in. Over the next week or so IV fell to around 35. If I ever see a similar situation Im jumping on it.


----------



## RichKid (10 March 2005)

I've seen some figures and charts from CommSec analysts (released in the media a few months ago) showing stocks are at historic lows for volatility, volatility has dropped sharply from long term averages. If I find the graph I'll post it, but I can't recall where I saw it. There was some discussion about it somewhere here on ASF too. Heard Guy Bower commmenting on it on his site or was it his newsletter?


----------



## positivecashflow (10 March 2005)

Here is chart of the CBOE VIX (Volatility Index).  Gives you a gauge of where volatility is at...


----------

