is there a Volatility Doctor in the house?

spindr0 · Jan 17, 2010

Quote from increasenow:

had some thoughts about this after I posted..

1-honestly, both of them DO NOT MATTER if you know the direction

2-the Historic Vol really matters only if you are trading like overnight or intraday or 1-2 days and need the stock/option to move

3-IVol really only matters if you are buying way too far out of the money

This is one of those "Everyone has an opinion" topics - often different.

IMO, IV matters if you're trading volatility, eg. forward and reverse calendars, calendar straddles and strangles, gamma scalping, etc.

IV matters if it's going to change while you're long or short the option .... ya know that famous question here where the noob asks why the stock moved up today but his long call lost money?
(IV collapse)

IV doesn't matter as long as it doesn't move against you

dagnyt · Jan 17, 2010

Quote from increasenow:

is there a Volatility Doctor in the house?...when trading options...what is the most important volatility reading?

The historical volatility of the Stock?

or...

Implied volatility of the underlying option?

There is no comparison.

Future volatility will (after the fact) determine what the option was worth.

IV is the the current estimate of future volatility.

When trading, you can bet on whether the current estimate is high or low.

But historical volatility is seldom important. Companies change, businesses grow, competition changes. HV has some value, but pales in comparison to IV.

In Oct/Nov 2008, did anyone care about historical stock volatility? The market was moving 5% every other day. HV was 100% meaningless.

If you must choose one of these as more important, please choose IV

Mark

jwcapital · Jan 18, 2010

Mark's comments are correct. I use IV to determine future trends by looking at ATM call's IV going out a few months. The key word is trend. I also take a look at VIX for absolute value as well as trend. Again, the key word is trend. Next to direction, volatility (IV, vega) is most important. And they are many option strategies that make money despite direction.

MasterAtWork · Jan 18, 2010

Hi Mark, happy new year,

Quote from dagnyt:

There is no comparison.

IV is the the current estimate of future volatility.

When trading, you can bet on whether the current estimate is high or low.

But historical volatility is seldom important. Companies change, businesses grow, competition changes. HV has some value, but pales in comparison to IV.

In Oct/Nov 2008, did anyone care about historical stock volatility? The market was moving 5% every other day. HV was 100% meaningless.

If you must choose one of these as more important, please choose IV

Mark

Sorry, IV has nothing to do with future volatility ! How the market would know it ?
IV is just what makes your pricing model match current quotes. Demand and supply for option make the price. And the price has nothing to do with IV. A pricing model does. That why it's called IMPLIED volatility.
Different models make different IV at the same time for the same option.
What about the skew ? At the same time you have different IV for the same maturity. Which one is the right for future volatility ?

Masteratwork

gkishot · Jan 18, 2010

Quote from MasterAtWork:

Hi Mark, happy new year,

Sorry, IV has nothing to do with future volatility ! How the market would know it ?
IV is just what makes your pricing model match current quotes. Demand and supply for option make the price. And the price has nothing to do with IV. A pricing model does.
Different models make different IV at the same time for the same option.
What about the skew ? At the same time you have different IV for the same maturity. Which one is the right for future volatility ?

Masteratwork

But how are the options quoted then without complete pricing model ( missing IV) ?

charts · Jan 18, 2010

Quote from increasenow:

is there a Volatility Doctor in the house?...when trading options...what is the most important volatility reading?

The historical volatility of the Stock?

or...

Implied volatility of the underlying option?

... feel free to google it. Don't rely on anonymous advice! There's no need for guessing ...

Don't start trading until you get a good knowledge foundation!

MasterAtWork · Jan 18, 2010

Quote from gkishot:

But how are the options quoted then without complete pricing model ( missing IV) ?

I didn't write something about quoting options without pricing model.
What I've written is that market doesn't know future. So, it doesn't know future volatility.
Again, if I pay $1 to buy a put and a pricing model shows that fair value is $ 0.15, it doesn't mean that I expect higher future volatility. Just that $1 stays a good price to me. I may have already sold this put for $5 and just want to buy it back !

Masteratwork

gkishot · Jan 18, 2010

Quote from MasterAtWork:

I didn't write something about quoting options without pricing model.
What I've written is that market doesn't know future. So, it doesn't know future volatility.
Again, if I pay $1 to buy a put and a pricing model shows that fair value is $ 0.15, it doesn't mean that I expect higher future volatility. Just that $1 stays a good price to me. I may have already sold this put for $5 and just want to buy it back !

Masteratwork

How are the options priced if IV is unknown?

MasterAtWork · Jan 18, 2010

Quote from gkishot:

How are the options priced if IV is unknown?

Well, you don't price an option with IV, you quote an option with IV. In some models like BS, you price an option with HV.
IV is always unknown. The only thing you could know is 'Black & Scholes pricing model implied volatility'. IV is model dependent. A SABR model would have a different IV for the same option, Black 76 model too.....Who's right ?

spindr0 · Jan 18, 2010

Quote from gkishot:

But how are the options quoted then without complete pricing model ( missing IV) ?

Option price is the equilibrium b/t supply and demand. If the ask is $2 and buyers come in, it rises (and vice versa for sellers).

If you iterate the option pricing components (other than vol) into a model, the result will be the implied volatility. People try to estimate future volatility but it's just that, an estimate. Future volatility is unknown. Implied volatility is a reflection of current prices.