Volatility/Standard Deviation

[tradingnoob9]

Giri, you don't need courses and sophisticated maths to 'get' the intuition behind options... No PDEs are necessary.

You just need to understand the basic premise behind the normal distribution and the idea of replication. You can get both of these from Hull or another basic option book.

Now, in your specific example the idea is simple. I could either hold the asset outright or I could hold a call option (let's ignore the whole risk-free bit for the moment). If I assume a relatively efficient mkt, I should be indifferent between which of the two to hold. The premium I pay for the call option should be determined by how much I expect the underlying to move on any given day before expiry. If you tell me that you expect it to move arnd 1.2% a day, I just annualize that to get a VERY rough idea of what vol to use for the option. This 1.2% is known as a 'daily breakeven', although I am not entirely sure people use these in equities.

Obviously, this calculation is EXTREMELY approximate and I am not even sure I did the whole thing correctly, but you get the idea.

Hi sorry for silly question, how how did you go from the 1.2% move expected per day to the 18% annualized vol ?

 

[Martinghoul]

Hi sorry for silly question, how how did you go from the 1.2% move expected per day to the 18% annualized vol ?

1.2% * sqrt(252), as I assumed there's 252 trading days in a year. Depending on your preference, you can use whatever convention you prefer, as long as you're consistent.

 

[tradingnoob9]

1.2% * sqrt(252), as I assumed there's 252 trading days in a year. Depending on your preference, you can use whatever convention you prefer, as long as you're consistent.

Ok i would agree with that if you said the daily vol was 1.2% and then you simply annualize it. But you are saying the daily expected move is 1.2%, which isn't the same as saying the daily vol is 1.2% right ?

 

[Martinghoul]

Ok i would agree with that if you said the daily vol was 1.2% and then you simply annualize it. But you are saying the daily expected move is 1.2%, which isn't the same as saying the daily vol is 1.2% right ?

Well, given the specified pre-conditions, what, in your opinion, is the difference between the two?