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It is essential to grasp the difference between the two kinds of volatility
that we are talking about here when applied to options trading. Historical
Volatility is the volatility of the underlying SECURITY over the PAST week,
month, year, whatever, whereas Implied Volatility is a GUESS of what the
volatility of the OPTION might be over the NEXT week, month or year.
'Historical' implied volatility is something else again being a history of
what everybody's guess was over a period of time. Typically, it is the
average of what the Implied Volatility WAS of the close-to-the-money
strikes BACK THEN.
When trading volatility, one theory is that a period of low volatility is
usually followed by a period of high volatility and vice versa. Because the
Implied Volatility (of the OPTION) has a big effect on the price of the
Option, the idea is to identify Options having low IV with a view to buying
them (because they're 'cheap') expecting IV to rise in the future or
identifying Options having high IV with a view to selling them, thereby
collecting a high premium. How you define high/low volatility or
cheap/expensive options is open to debate.
Therefore, from end-of-day data, you can only plot the Historical
Volatility of the underlying security. There is no way that you can deduce
the 'historical' IV from EOD security prices. As I mentioned before, in
order to do that you must have access to the history of GUESSES. I
apologise for misleading you regarding the availability of free IV data at
OptionsXpress. If you have a trading account with them, you get that
information free. I have attached a sample chart for you showing what IV
looks like when plotted against HV and the EOD price of the security.
Perhaps it's an indication of how valuable that information is that it is
not simply given away.
One of Don Fishback's recommended strategies is to scan for securities
having very low short-term HV. You can do this with the Metastock Explorer.
First, identify securities having the 10 day HV less than 0.5 of the 100
day HV:
(Std(Log(C/Ref(C,-1)),10) * Sqr(365))
<0.5*(Std(Log(C/Ref(C,-1)),100) * Sqr(365))
It is traditional to use a calendar year (365 days) for this calculation.
Then calculate the H/L range within which these securities have traded over
the past 10 days:
(( HHV(H,10 ) - LLV(L,10))/C) * 100
Now identify those securities whose H/L ranges are within 5% of their
lowest 10 day trading range over the last year:
LLV( (( HHV(H,10 ) - LLV(L,10))/C) * 100 ,253)
I have used the approximate number of trading days in the year (253) for
this calculation.
This exploration should produce a list of securities currently trading at a
yearly low Historical Volatility and a therefore potential candidates for,
say, straddle purchases. You must now make use of the Metastock Optionscope
calculator to ensure that the IV is ALSO currently still low before
progressing further.
I sincerely hope that this helps you.
Regards,
Kevin
At 09:47 10/04/2003 +0800, you wrote:
>
>Kelvin,
>
>I assume option volatility in Metastock is base on EOD although Pro version
>has both EOD and RT. However I am not sure if you download intraday data,
>will the option volatility be computed based on the intraday. I couldn't
>access the formula of it, otherwise we can examine to see what it does. By
>an chance, do you have its formula ?
>
>Do you have information on Don Fishback, it seems that you know quite a
>bit. I could modify the period and percentage in Don's indicator to show
>different coverage on chart. But I really need to understand how to apply
>it for option analysis - need application notes. I can do paper trade to
>evaluate it's truth.
>
>I viewed OptionsXpress site, you must open an account in order to access
>the charting of "Historical IV". Could you demo and capture a screen of it
>and post it to me. Btw, are you a member there ?
>
>Best Regards
>Freddie Ng
>
>At 06:20 PM 4/9/2003 +0100, you wrote:
> >I have noticed a few posts recently suggesting that the Metastock Option
> >Volatility indicator plots implied volatility. I suggest a little caution
> >here. There is not sufficient data in stock end-of-day prices to calculate
> >the implied volatility of the options on that stock. In order to do that,
> >you would require the option prices for the complete chain. Also, bear in
> >mind that options for different strike prices may well have different
> >implied volatilities. Sometimes the difference is quite marked.
> >
> >The Option Volatility indicator can only be based upon some kind of
> >historical volatility formula. Therefore, if you are comparing this to,
> >say, the Fishback historical volatility indicator, which is based upon a
> >linear regression calculation, you are comparing like to like and it will
> >be of no use to you for options trading.
> >
> >In order to see 'historical' implied volatility, you will need to access a
> >website that has all of that data stored. I think that OptionsXpress will
> >let you chart 'historical' IV on particular stocks for free.
> >
> >Regards,
> >Kevin
>
>
>
>
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>
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>
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