What is Implied volatility?

Implied volatility is a number displayed as a percentage, reflecting the degree of uncertainty, or risk perceived by traders.

Metrics of implied volatility, taken from the Black-Scholes option pricing model, can indicate the expected change in some indices, stocks, commodities, or major currency pairs. be specific in a certain amount of time.

For example, the popular VIX is simply a 30-day implied volatility index for the S&P 500 index. A high VIX threshold, or a measure of highly implied volatility, indicates that the risk is relatively high and It is more likely that the price will fluctuate larger than usual.

Implied volatility vs historical volatility - what is the difference?

Implied volatility is the expected size of future price change. It reflects how large or small a move is predicted over a particular time frame.

Historical volatility, also known as observed dynamics, indicates the actual size of the previous price change. It illustrates the overall level of market activity that has been observed.

The ATR (Average True Range) on an asset or stock is an example of an indicator that illustrates historical volatility.

Although the implied volatility and historical volatility are slightly different in terms of future expectations compared to past observations, these two numbers are closely related and tend to move in line with each other. Similar models.

Measures of implied volatility are often higher when there is a large degree of uncertainty relative to potential market influence - and often surround economic data releases or risky events. Other calendars like central bank meetings. This can lead to greater price volatility and, therefore, can be realized into higher realized values.

Likewise, when historical volatility is maintained under stable market conditions or when perceived risk is relatively low, volatility implies a lower trend.

Implied volatility can reflect market risk and uncertainty

Volatility implies a forecast of how much market movement is expected - regardless of which direction is headed. In other words, implied volatility reflects the expected price range of potential outcomes, and the uncertainty around the top or bottom of an underlying asset can go up or down.

High implied volatility shows a high probability of the large price volatility that traders expect, while low implied volatility signals the market to expect price volatility to be relatively stable.

Implied volatility metrics can also help traders measure market sentiment when looking at broadly describing the degree of uncertainty - or perceived risk.

Implied volatility trading ranges may imply technical support - resistance levels

Implied volatility metrics can also be combined into different trading strategies. This is due to their usefulness in identifying potential areas of technical support and resistance.

Implied volatility range is usually computed on the assumption that the price will be in a move with 1 standard deviation. Mathematically, this means that there is a 68% statistical probability that price action will fluctuate within a specified range of implied volatility within a particular timeframe.

As such, if the trade price is above the upper limit of its predetermined implied volatility range, there is an 84% statistical probability that the price will be sucked lower and a 16% probability that the price will. continue to increase.

On the other hand, if the price trades at the lower resistance of the predefined range of implied volatility, then the 84% statistical probability that the price will rise higher and 16% probability that the price will continue to decline. .

The advantages of volatility are implied as a trading signal

In large part due to the inherent mean-reverting of major currency pairs, implied volatile trading ranges often act as strong Forex signals.

For example, this EUR / GBP analysis identifying the 24-hour implied volatility trading range for EUR / GBP provides an illustrative example of how these technical barriers can help traders. identify potential pivot points and trading opportunities.

Using these inputs, and making the range of options based below, it is estimated that EUR / GBP will fluctuate between implied support of 0.8508 and an implied resistance of 0.8574 over 24. hours to come with 68% statistical probability.

In other words, the calculated 24-hour trading range reflects volatility implying a standard deviation of +/- 0.0033 from the spot price, meaning volatility in the EUR / GBP forecast. The ant will be in a band of 66 pips around the current price which is 0.8541 for the session on 15/01/2020.

Use implied volatility to trade commodities, stocks, and indices

As mentioned above, measures of implied volatility can indicate overall market uncertainty. Accordingly, implied volatility benchmarks on cross-assets tend to reflect a useful relationship with their respective underlying markets and can provide information. detailed information about where that market could go.

Arguably the most commonly implied volatility benchmark is the VIX over the S&P 500. The VIX index often rises amid market turbulence and increasing uncertainty, despite "a measure of fear. fear "tends to increase in mass sell-offs. In return, the VIX index usually has a strong inverse relationship with the S&P 500.

The OVX index, which reflects the expected 30-day volatility in crude oil prices, provides an example of another commonly considered implied benchmark level. Crude oil prices and stocks react similarly to the worsening of risk appetite, so it is not surprising that crude in relation to market sentiment often maintains a negative correlation with both the VIX and the OVX indices...

Although this inverse relationship is often observed between the price of an asset and its measure of implied volatility as a general rule, it is not always true and has some of the most exceptions. concentration.

The correlation of price with the implied volatility is dynamic, meaning it is constantly changing, corresponding to a relative strengthening or weakness from their historical volatility.

Similarly, when it comes to common safe-haven assets, it is possible to show a direct relationship between price and implied volatility.

For example, the US Dollar Index (DXY) is generally trending up and down of expected currency volatility (FXVIX).

In addition, a positive correlation is often reflected by the price of gold and the volatility of gold price (GVZ).

These examples help to illustrate the value that implied volatility can bring when combined into other comprehensive macro approaches and trading strategies.