Dr. Data's Revenge: Actual Volatility
Aug 12, 2015
By: Sage Anderson
The market may believe it's perfectly efficient, but on today's blog, Dr. Data sets the record straight - at least in terms of equity options.
Implied volatility is the number we can reverse-engineer from current option prices to calculate "fair value" for volatility. This is the level of volatility that the market expects will come to pass through the stock's future movement over a given period of time (present through expiration).
The question that Dr. Mike Rechenthin (aka Dr. Data), Tom Sosnoff, and Tony Battista examine on this episode of The Skinny on Options Data Science is related to how successful implied volatility (market volatility) has been in predicting actual volatility.
The research team's hypothesis was that actual stock moves would generally not be as large as those implied by the options market.
The parameters of the study that the team utilized to find a conclusive answer to this question included the following:
The graphic below illustrates the three expected outcomes from such an exercise:
The results of the study actually came back exactly as the team expected. In their research, implied volatility overstated actual volatility on 77% of trading days. That meant utilizing strategies that involved selling premium would have been profitable 77% of the time in this set of stocks over the last 12 months because the stock prices didn’t move as much as the volatility predicted.
Depicted below is a "normal" distribution of implied volatility versus the actual performance of implied volatility in this study. As you can see, the difference between the distributions of implied volatility and actual volatility shows that on average, in this study, implied volatility overstated the expected moves of the stocks.
ffectively, Dr. Data, Tom, and Tony have shown that the market isn't always perfectly efficient at pricing risk, especially as it relates to equity options volatility.
We encourage you to watch the entire episode discussed above by following this link.
Additionally, the entire content of library from the Dr. Data series The Skinny on Options Data Science can be accessed by following this link.
Thank you for reading and please leave any feedback on past or future programming below!
Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.
Sep 7, 2017
Most investors are familiar with what earnings are, but less know about the different strategies and considerations when investing in a company with upcoming earnings. In this post you will learn about what earnings are, the terminology associated with earnings, and how you can place an 'earnings trade.'
Feb 21, 2017
Implied volatility rank (or IV rank for short) is a newer concept in the options trading industry. Any option traders knows what implied volatility is and how it relates to the pricing of options, but few understand what IV rank is. IV rank is a measure that brings relativity to implied volatility.
tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.
tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.
Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.
Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.