How Margin Agreements Work
Range Trading Strategy in Day Trading
How to Spot Trend Changes when Day Trading

The Volatility Ratio Puts Market Volatility into Historical Perspective

The volatility ratio tells day traders what the implied volatility of a security is relative to the recent historical volatility. This ratio shows whether the security is expected to be more or less volatile right now than it has been in the past, and it’s widely used in option markets.

The first calculation required is implied volatility, which is backed out using the Black-Scholes model, an academic model for valuing options. When you plug in to the model certain variables — time until expiration, interest rates, dividends, stock price, and strike price — the implied volatility is the volatility number that then generates the current option price. (You don’t have to do these calculations yourself because most quotation systems generate implied volatility.)

After you have the implied volatility, you can compare it to the historical volatility of the option, which tells you just how much the price changed over the last 20 or 90 days.

If the implied volatility is greater than the statistical volatility, the market may be overestimating the uncertainty in the prices, and the options may be overvalued. If the implied volatility is much less than the statistical volatility, the market may be underestimating uncertainty, so the options may be undervalued.

blog comments powered by Disqus
How to Interpret Trendlines when Day Trading
Day Trading Using a News Trading Strategy
Pitfalls of Technical Analysis when Day Trading
Take Advantage of Stock Price Discrepancies while Day Trading
What the Accumulation/Distribution Index Can Tell a Day Trader
Advertisement

Inside Dummies.com