Volatility measures the magnitude of price changes. By contrast volatility does not measure the direction of prices changes, only the magnitude. Volatility is used in many areas of the capital markets.
In the options market, several types of volatility are used. They are:
Historical Volatility is the Standard Deviation of price returns (daily percentage price change) exprssed as an annualized figure. Historical Volatility tells us the magnitude of price change rather than the direction of price change.
Historical Volatility is Calculated like a moving average using any number of days one desires. However, it’s best to avoid time periods too short or too long. Using a short time period, say 5 business day – will yield a very erratic result when viewed over time. Also, 5 day historical volatility will be adversely effected to one days change in the market.
Omn the other side, if one chooses to look at the average volatility over a longer time period, say 200 business days. When viewed over time, the 200 day historical volatility number will include data that is more than 6 months old. It may tkae into account more information than you need.
Implied Volatility is the volatility implied by the price of an option. In a liquid options contract, it is the markets expectation of the volatility of the underlying asset to the expiration date of the option.
Forecast Volatility is one person or one firms expecation of volatility over the next N time period.
Event Volatility is the heightened volatility the market (or asset) experiences when an event is forthcoming or announced. Some people measure Event Volatility as the differential between “normal” volatilty and the volatility experienced when news or information is forthcoming.
Seasonal Volatility is used for commodity markets to describe the heightened (or dampened) volatilty the market experiences at different point in the commodity’s growth cycle or production chain.
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