Historical VolatilityWhen considering volatility we can look at the historical volatility of an option or predictions of future volatility. Historical volatility (HV), an easier concept to understand compared to implied volatility, is the statistical analysis of past variation in volatility for a given option (or any other financial instrument for that matter) This analysis is based on recorded observations, usually over a given time period. The standard time period is 21 days. The closing prices of a given option is tabulated for the last 21 days and converted to a volatility number, given in percent, from 0 to 100. High historical volatility numbers indicate the option’s prices have been up and down erratically over the last 21 days. Low HV numbers correspond to options whose prices have been fairly stable, and often fairly low, over the past 3 weeks. HV tends to be higher when prices fall. This is because falling prices initiate fear in the marketplace and this in turn drives volatility up. You can look up HV for any given option on many online sites. One excellent online site for this is IVolatility.com. Of course the good options-friendly brokers, such as OptionsXpress, provide this information as well. The information is usually presented in a graphical format for ease of interpretation. Lets start to think how this can help us as safe options sellers: Option premium will be high when volatility is high. Conversely, premium will be low when volatility is depressed. On one hand we know when we sell for option premium we want to sell at a high enough price to make it financially meaningful to us. On the other hand, we don’t want to get too greedy because if we sell too high, these options are likely to be to be exercised and as a safe-option-seller we don’t want that to happen in most cases. By taking a look at HV we can get a good handle on the past range of an instrument’s price range, and this can assist us in deciding whether it is a good time to sell the option or not. One simple example we can consider is the sale of an out-of the-money covered call. Imagine that we own 100 shares of ABC. We bought it at $20/share. It has risen to $21/share and we are considering selling an out-of the-money call at a strike price of $25 to gain incremental income. We take a look at HV graph for ABC and we note that the most recent HV of ABC is higher than the typical HV,. This tells us that the call premium we are thinking of is probably relatively high, and we can pocket a nice premium. Begin paying attention to HV. It will help you as you continue on the successful road to safe option selling.
Return from Historical Volatility to Options Volatility
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