Today, on this segment of "The Skinny On Options Math" Tom Sosnoff, Tony Battista and our math genius Jacob Perlman explain the concept of the volatility of volatility, what that really means and how the term is often misused.
The volatility of an underlying is the standard deviation of its annual returns. When we move beyond our Black-Scholes conditioning we realize that volatility is not a constant but instead varies over time. It therefore makes sense to examine the standard deviation of volatility or volatility of volatility.
Once we realize volatility is not constant we see the need for measuring the change. The term volatility of volatility is used for all the methods of measuring volatility's change. The volatility of volatility phrase becomes unclear and this segment attempts to clear things up.
Sometimes when someone says volatility of volatility they are referring to one of the second order greeks. Ironically, even though Black-Scholes conditions us to look at volatility as a constant it can be used to compute Vol of vol.