Implied Volatility

Written by Emilu Bailes on . Posted in Instructors Blog

This term is used to express the relative rate at which the price of a security moves up and down.  If the price of an equity moves up and down rapidly over short time periods, it has high volatility.  If the price almost never changes, it has low volatility.

300px VolatilityDJIAunscaled Implied Volatility

Volatility (Photo credit: Wikipedia)

Last year (2011) was a very volatile year on Wall Street.  It was a year dominated by alarming headlines.  It’s no surprise that the euro zone debt crisis was a repetitive theme on headlines everywhere.  Additionally, in early August, the U.S. debt ceiling was raised to avoid default, followed by Standard and Poor downgrading the U.S. debt for the first time ever.  They cited a small but growing threat of a default as Congress and the White House battled over the debt ceiling.

One of the tools investors use to watch volatility is the VIX.  Although this tool is a calculation of Implied Volatility on a blend of price ranges of options on the S&P Index, it is also helpful in measuring the market’s expectation of stock market volatility over the next 30-day period.  What did the VIX do during 2011?  It gyrated between a reading less than 15 to near 50!  Since it is commonly called the ‘fear index’ it isn’t surprising that the surge near 50 was at the time of the S&P downgrade of our debt.  Where has the VIX been this year?  The highest reading year-to-date has been less than 30 and a low reading below 14.  What’s different about 2012 and 2011?  Has the euro debt crisis been resolved?   Has Standard and Poor revised their rating on the U.S. debt?  No!

Perhaps the investing community has simply been exposed to this news for so long that the fear has subsided.  After all, have any European countries defaulted?  Has the U.S. been stopped in its tracks?  It is said that volatility rises naturally in the face of ‘uncertainty.’  New news has a stronger chance of striking fear in our hearts.  Old news that hasn’t resulted in terrifying consequences simply lacks that power.

Emilu Bailes
OptionsANIMAL Instructor

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