Does implied volatility lead the spot price?

Does implied volatility lead the spot price?

Sometimes yes, sometimes no. Implied volatility is a market expectation of the future, and as we all know, the market doesn't always get it right. For example, IV will often rise ahead of a key event like an earnings release. Many times, however, that release causes little reaction in prices, and IV eventually falls back.

All depends on the timeframe you're talking about really. And it's a much more complicated argument than it may seem.

There is little doubt that the wholesale otc options market has a huge and still growing effect on the underlying cash (spot) market. Not just in terms of event risk related swings in shorter term vol, but also in terms of longer term positioning, the influence of large barriers and expiring strikes etc on the market etc etc.

So there's probably not a straight 'yes or no' answer to the question.

I personally think it would make someone an excellent research project / dissertation topic one day. Could talk in depth about the different factors driving the relationship. Could test for granger causality etc etc. Plenty there.

The nature of the relationships, if one exists, would also depend on the asset class, so you would have to narrow it down a wee bit.

very true.

A finance professor friend of mine offered up these links as examples of some of the academic research that's already been done on the subject, though they are probably not quite what Schopen was thinking:
CXOAG Investing Notes - The Implied-Realized Volatility Gap as Return Predictor
http://www.eurojournals.com/irjfe_27_15.pdf

interesting. Would be a bit wary of conducting research on Vix / S+P though - seen a few things floating around talking about the effect of short stock ETFs on the level of the Vix - I have a feeling it's prone to a few odd structural hiccups.

I can see there is lot more to this - I found myself googling in the vicinity of variance swaps vs volatility swaps - but that looked like slightly deeper water and I'm really just trying to get a bead on how all the basics interact.

Can 'false' IV movement be traded against the spot price in some way?

Also if IV can be used to trade synthetic futures against real ones, and treat 'false' IV as a mis-pricing that will correct and can be profitted from in some way, other than trading volatility change in the traditional way.

I've read that when implied volatility goes up, prices of both calls and puts go up. So if I am long a synthetic future, can I make an assumption that if IV goes up I will lose on the put but make on the call, does this mean the future won't really change in value much..?

If the spot price price goes up, the 'real' future will, but will the synthetic future go up in price too, and will this be because of the increase in the spot price input of the model that priced it?


I'm also wondering does IV ever predict spot price direction as well as movement?

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'I will trade. Oh yes. I will trade.'

There's a lot of concepts you need to have a grasp on if you're looking at this.

Suggest you read up on the following concepts to help you ....

1) Put/Call Parity
2) Risk Reversals
3) Voltility Smile
4) Volatility Skew

you may find these interesting

GJ

i think looking briefly you are saying if IV goes up it follows underlying price goes up. correct me if i'm wrong.

if so that is not the case

I think the OP is kinda looking for answers more than proposing theories as far as I can tell Goose. But it's a complex topic.

it is and very intersting one too