Historical Volatility is the annualized movements of a stock
or ETF over a given time frame. One might look at the past 30
days of a stock's closing prices and, by observing those price
movements, determine that it has been moving at a 30% volatility.
You can do this by simply extrapolating those movements into an
Of course, just looking at 30 days of data would not give us a
very accurate depiction of how a stock or ETF moves, so we need
to look back at a year or more of data to get a more accurate
reading of volatility. I like to use one year periods or even
five year periods so that I have a good understanding how the
stock or ETF moves in low and high volatility periods. I often
discuss this in great detail in the
Implied Volatility is what the options market implies the
volatility will be for a stock or ETF in the future. Implied
volatility is calculated backward from an options price. In other
words, if investors are paying more for options, implied
volatility is rising and vice versa if investors are selling
When you think about the strategies options traders use,
it makes perfect sense. If you think the market is going to move
swiftly in one direction, options strategists would tell you
a vertical, straddle, strangle, call, or put. That's buying low.
If you thought the market was going to move at a lower rate,
strategists would tell you to sell one of the aforementioned
strategies. That's selling high.
Typically, when traders become more scared of the unknowns in the
market, which often means a high implied volatility, traders buy
protection in the form of puts and/or speculating on a rise in a
stock or ETF by purchasing calls.
In the world of options we can literally witness fear being built
into or out of options, without any change in the underlying
stock price; this fear is represented by a high implied
volatility which means higher options prices (premium).
So how, as options traders, can we use historical and
implied volatility readings to our advantage?
It is simple, well almost, when comparing a stock or ETF's
historical volatility to its implied volatility: buy low and sell
high. This goes for absolutely everything, including volatility,
especially if you want to be a successful options trader.
If you would like more information on volatility and how to use
them in your
visit CBOE.com to learn more
You can use various volatility screens that will assist you in
making the most sound decisions on what underlyings to use in
your next trade. Knowing how the historical volatility compares
to implied volatility is a MUST if you want to be successful