+60% and -60% approximately 99% of the
time. Statistically, vol is one standard deviation. But that’s about as much as historical
and implied vols have in common.
IT’S HISTORY. OR IS IT?
Historical vol is based on price changes
for a stock or index over a period of time.
That time can be a year, 10 days, or any time
period. It doesn’t change for a given set of
data, because a stock’s past price changes are
what they are.
To calculate historical vol, you’ll have
to do some mathematical calculations, but
don’t sweat the heavy stuff. Historical vol is
available on the thinkorswim® platform by
TD Ameritrade as a study on the Charts tab.
Select Studies > Add Study > All Studies
and find Historical Volatility.
Implied vol or IV is a tad more complicated
to calculate. It still uses the stock price in its
calculation. Unlike historical vol, though, IV
Historical or Implied—What’s the Diff?
LOOKING AT BOTH MAY HELP YOU DECIDE IF THE MARKET’S
EXPECTATIONS ARE REALISTIC OR WAY OFF BASE.
• PRO / TAKE AWAY: Figure out if volatility is on track or has veered off course.
• VOLATILITY IS LIKE A SUNSET. You’ve
seen one, you’ve seen ’em all, right? Well, yes
and no. Sure, volatility (“vol”) means how
much the price of a stock or index might
change. High vol suggests the market anticipates bigger potential future price changes.
Low vol means the market anticipates smaller future price changes. Simple enough. But
there are in fact two main volatilities you’ll
typically encounter—historical and implied.
And although they both refer to a price
change’s potential magnitude, they’re calculated and employed differently.
Whether historical or implied, vol is
always a percentage, and usually an annualized number. If vol is 20%, for example,
a stock or index might be 20% higher or
20% lower in a year’s time. Further, vol is
a standard deviation of price changes. So
theoretically, in one year, the stock will be
within +20% and -20% of its prevailing price
approximately 68% of the time. The stock
will theoretically be within +40% and -40%
approximately 95% of the time, and within
is always changing because option prices shift
constantly, depending on how the market
anticipates future price moves.
If you think a stock might make bigger price
changes, option prices increase, which in turn
increases implied vols. Conversely, if you don’t
anticipate big changes, option prices
decrease, which decreases implied vols.
Analyze historical vol to see how volatile
a stock or index has been in the past, and
implied vol to see how volatile the market
anticipates a stock or index might be in the
future. Compare the two to determine if one
is higher than the other. For example, if you
believe historical and implied vols should
follow each other up and down, but you notice that implied vol is higher than historical, that could suggest implied vol overstates
a stock’s potential price change. If implied
vol is lower than its historical counterpart,
that could suggest implied vol is understating potential price changes.
Getting your mind around vol isn’t a
trading strategy per se, and you shouldn’t
base decisions solely on the movement and
relationship of historical and implied vols.
But comparing them may help you peer into
how the market feels.
For a fuller picture of historical and im-
plied vols, add them on Charts (see Figure 1).
By default, the two studies appear on separate panels. But if you go to the Edit studies
section and click on the up-facing arrow on
the lower study, it’ll move it to the same panel
as the upper study. This overlays historical
and implied vol data.
With a little practice, you can mine vol
territory fairly quickly for potential insights.
Again, use implied vol to see what the market might be thinking, but turn to historical
vol to see if the market may have veered off
track. Think of it as checking the weather
before you leave the house. You can’t control
a downpour. But you can grab an umbrella
and be a little more prepared. —Words by
FIGURE 1: Historical and implied vol overlay. Place one on top of the other so you can see when and how the two
move together or differently. Source: TD Ameritrade. For illustrative purposes only.
Thomas Preston is not a representative of
TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the
author and may not be reflective of those held by
TD Ameritrade, Inc.