Volatility Explained

Volatility is the key parameter which drives options trading

Volatility is a measure of how much something moves. When traders discuss volatility, they’re referring to one of:

• The price swings of an asset (market volatility)

• The implied volatility of options (IV)

Historical Volatility

The market volatility of an asset is a result of the observed day to day swings in price. This is volatility that is in the past, and is why we say things like ‘crypto is a volatile asset class’ and ‘bonds are stable, safe yielding assets’. This is referred to as ‘historical’ or ‘realized’ volatility.

With assets, historical volatility is a measure of how much the price changes over a given period of time. If an asset is expected to move 2% per day, and instead moves 10%, it would be referred to as having realized ‘high volatility’.

Similarly, if an asset normally moves 5% per day, and only moves 2%, it would be realizing ‘low volatility’.

Implied Volatility

On the other hand, implied volatility is the market’s expectation of how much an asset will move, and is reflected in the price of options expiring in the future.

This is effectively an estimate - the market can guess that an asset will move 10% over the next month, but it might move 50% (or not at all). An option with an implied volatility of 50% is saying that the underlying asset is expected to trade within a 50% range (high to low) within the next year.