volatility calculation

All,
Can anyone tell me which measure of historic volatility is best suited to valuing options? I've been looking at this and am confused by the different measures of historic volatility I've encountered. Nothing has given me an insight into which is the correct measure for options analysis.

Any insights provided will be greatly appreciated.


Thx,
D

fundjunkie said:

Can anyone tell me which measure of historic volatility is best suited to valuing options?

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You don’t value options by historic volatility (HV).

If you want to know the theoretical value of an option you input the implied volatility into the equation. Or, if you already know at what £ value an option trades, you can derive it’s implied volatility. HV doesn't feature in the calcs.

fundjunkie said:

I've been looking at this and am confused by the different measures of historic volatility I've encountered.

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There aren’t “different measures” of HV, only different time frames. Maybe that’s what you mean.

fundjunkie said:

Nothing has given me an insight into which is the correct measure for options analysis.

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A good book on option theory will do the trick.

Profitaker said:

You don’t value options by historic volatility (HV).

If you want to know the theoretical value of an option you input the implied volatility into the equation. Or, if you already know at what £ value an option trades, you can derive it’s implied volatility. HV doesn't feature in the calcs.

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I know that. I'm interested by comparisons of historic and implied volatility as an indicator of relative value.

Profitaker said:

There aren’t “different measures” of HV, only different time frames. Maybe that’s what you mean.

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I'm aware of multiple measures of volatility and academic and professional friction regarding the best measure. As I know others have done the same kind of analysis I'm looking into there may be one that is most suited to this application. Hence my question.

Profitaker said:

A good book on option theory will do the trick.

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Am always reading and trying to learn. It is that study that has prompted this query. But maybe this isn't the right forum in which to address it.

fundjunkie said:

I'm aware of multiple measures of volatility and academic and professional friction regarding the best measure.

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I think you'll find that (almost) everyone uses the standard deviation of (log) price returns.

What alternative methods are you talking about ?

Fundjunkie

I don't think you will find one measure of HV which you can compare with an option's IV to determine whether a particular option is over priced or underpriced. There are discrepencies between HV and IV and these can persist in relation to a particular underlying for an extended period of time. It is interesting to chart historic IV together with historic actual vol. for some different time frames. That can enable you to make some observations such as "this stocks IV is much further above the 20 day HV (or 10 day or 50 day or whatever) that it normally is" but even then these are simply observations and you need to ask yourself if there is a likely reason for what you see. It can stop you taking positions in strategies completely against the current IV though such as buying straddles before earnings when IV is high possibly indicating the rest of the market has already got in before you.

Sorry if this is not helpful to what you are asking.

Best Regards

garethb said:

Fundjunkie

I don't think you will find one measure of HV which you can compare with an option's IV to determine whether a particular option is over priced or underpriced.

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I agree. They're different. I'm preparing to try to determine how different and whether information can be gleaned from the knowledge.

garethb said:

There are discrepencies between HV and IV and these can persist in relation to a particular underlying for an extended period of time. It is interesting to chart historic IV together with historic actual vol. for some different time frames.

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It's interesting that you mention historic IV values. I don't currently have access to historic option chains but plan to do so. What do you use as your data source?

garethb said:

That can enable you to make some observations such as "this stocks IV is much further above the 20 day HV (or 10 day or 50 day or whatever) that it normally is" but even then these are simply observations and you need to ask yourself if there is a likely reason for what you see.

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I shy away from guessing the reasons for this or that, though I take you point.

garethb said:

It can stop you taking positions in strategies completely against the current IV though such as buying straddles before earnings when IV is high possibly indicating the rest of the market has already got in before you.

Sorry if this is not helpful to what you are asking.

Best Regards

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Agreed, but while what you say is very likely true and makes sense I like to prove things to my own satisfaction. Thanks for the feedback.

There are various historic option price data provided as downloads from many exchanges particularly for some of the options on index futures. Just hunt around the sites for the options you're interested in. I am only an occasional trader of US stock options on a medium term basis and my broker (tradestation) provides a calculated end of day IV history on optionable US stocks but not the individual option price data history so you have to accept their calculation. I'm sure there are better brokers and data feeds if you are going to specialise in option trading.


In my view trying to build an edge on volatility analysis alone without "guessing the reasons" for discrepencies is a very hard job, particularly for players on the "outside" of the market. Only a personal opinion of course of which there are many and very strongly held on the options forum particularly - so best of luck in your search.

garethb said:

In my view trying to build an edge on volatility analysis alone without "guessing the reasons" for discrepencies is a very hard job, particularly for players on the "outside" of the market. Only a personal opinion of course of which there are many and very strongly held on the options forum particularly - so best of luck in your search.

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You're right. I don't particularly expect to find anything but I'll learn many things

Profitaker said:

I think you'll find that (almost) everyone uses the standard deviation of (log) price returns.

What alternative methods are you talking about ?

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That's good enough for me. If the big boys use that then that's what I'll use. There's 3 or 4 methods of varying complexity which I've come across including the one you've mentioned. Unfortunately, historic volatility references I've come across on different sites and readings from the volatility indicator(s) in my own software contradict each other. That's what caused confusion and prompted my query.

fundjunkie said:

That's what caused confusion and prompted my query.

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Well, if you get stuck and post a series of historic stock prices, I'm sure we'll work through an HV calc with you here.

If you're looking for some sort of "black box" Volatility forecast then have a look at the (G)ARCH methodology. Lot's of info on the web, but some serious drawbacks IMHO.

Good luck.

fundjunkie said:

That's good enough for me. If the big boys use that then that's what I'll use. There's 3 or 4 methods of varying complexity which I've come across including the one you've mentioned. Unfortunately, historic volatility references I've come across on different sites and readings from the volatility indicator(s) in my own software contradict each other. That's what caused confusion and prompted my query.

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I was one of the "big boys" and traded equity derivatives at Salomon....I can tell you in all honesty,we sliced and diced vol and in the end,there is no measure that stands out....Waht I do think you should look at is intra-day or high low vol vs close vol and decide upon your hedging frequency.