Methodology
How to read and use IVolatility numbers?
What is the methodology used in calculating the IV index?
Does the IV index represent only the at the money options volatility?
What is the difference between IV Index Call and IV Index Put?
Why do you normalize the IV index to fixed maturities (f.e. 30 days)?
How many expirations do you use for IVIndex calculations?
Is any weighting scheme applied to the calculation of historical volatility?
In the Vol Ranker what maturity are you using for IV Index last and change?
What models and what market inputs do you use?
What is Volatility Skew?
How far back do you have Implied Volatility on individual stocks and indices?
What is a 'current option price' you use for IV calculations?
Q: How to read and use IVolatility numbers? |
A: There are several numbers you may want to look at, e.g. comparing Historical volatility (HV) against Implied volatilities (IV Index) gives you some idea if options are cheap or overpriced relative to the historical moves in the underlying stock.
Looking at IV Index Call and that of Put gives you an idea of the market's bias on options prices, maybe indicating the market's expectation of a move. Looking at the IV Index Hi/Low indicator gives you an idea whether options are cheap or expensive relative to where the Implied volatility has been over the last 52 weeks.
Other indicators are changes in volatility. If you notice a big change in Implied volatility from one day to the next, without a large move in the underlying stock (or significant change in the HV), it could suggest some buying or selling in the options markets based on some rumors or expectations of a large move.
There are many different ways to analyze and use the numbers. The above are only some suggestions that can give you a start.
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Q: What is the methodology used in calculating the IV index? |
A: We collect option prices for 4 nearest by strike to stock price options for the all expirations. These prices are converted to Implied volatilities and then averaged using a proprietary weighting technique factoring the delta and vega of each option. The IV is then normalized to 7, 14, 21, 30, 60, 90, 120, 150, 180, 360, 720, 1080 days fixed maturities. To read more about our methodology please go to Education section: Implied Volatility Index (IV Index)
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Q: Does the IV index represent only the at the money options volatility? |
A: No. We take four nearest to the spot strikes that includes at the money, out of the money options and in the money options. Thus our IV represents a better average of the Implied volatility of the options markets.
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Q: What is the difference between IV Index Call and IV Index Put? |
A: IV Call represents the weighted average of the Implied volatilities of the out of the money call options, while IV put represents that of the put options. The two provide information on how the options markets are pricing calls vs. puts, i.e. the skew of Implied volatility
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Q: Why do you normalize the IV index to fixed maturities (f.e. 30 days)? |
A: Normalization of the IV index to a constant maturity allows correct comparison of IV data in a historical perspective. Comparing the IV of the average of one of a few maturities over time is commonplace, but this practice is not very accurate as the average number of days that the Implied volatility is representing is not constant.
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Q: How many expirations do you use for IVIndex calculations? |
A: We use all available expirations. Implied Volatilities are calculated for all options and then using weighting scheme we calculate the fixed terms of IVIndexes.
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Q: Is any weighting scheme applied to the calculation of historical volatility? |
A: We do not apply any weighting scheme, but use the most widely accepted method of calculating close-to-close Historical volatility.
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Q: In the Vol Ranker what maturity are you using for IV Index last and change? |
A: Ranker uses the same IV index as described above
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Q: What models and what market inputs do you use? |
A: We use Black-Scholes model for calculation IV for European Options and for American Calls on underlying without dividends. Cox-Ross-Rubinstein binomial tree model with 100 steps is used in other cases. We maintain current stock dividends and current interest rates in our database, and use them for pricing model inputs. Specifically, we use LIBOR interest rates.
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Q: What is Volatility Skew? |
A: Volatility Skew is the difference in the Implied Volatility between out
of the money calls and out of the money puts.
Typically Implied volatilities across different strikes exhibits what
traders refer to as a "smile", i.e. out of the money options have slightly
higher volatilities than at the money options. But sometimes the "smile" is
"skewed", i.e. equally out of the money calls and puts differ in their
Implied volatility.The skew thus represents the markets bias towards calls or puts. In
iVolatility.com we show the skew as the ratio of Call volatility to Put
volatility. Therefore, a number greater than 100% means Calls are priced higher
than Puts and vice versa. This shows that the market has a positive bias
towards the upside, while if this number is less than 100% then puts are
being valued higher.Very high skew numbers could suggest a strong bias in the view of the
market's opinion of the stock. For example, if the skew suddenly drops, it could suggest that there is a rumor afloat and the market
is getting nervous about the downside of a stock and thus loading up on puts
and selling calls.
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Q: How far back do you have Implied Volatility on individual stocks and indices? |
A: Our database for Implied Volatility Index 30 days goes back to May 1999; 60, 90, 120, 150, 180 days terms of IVIndexes goes back to November 2000. Our Historical volatility database goes back further - on some stocks as far
back at 1995.
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Q: What is a 'current option price' you use for IV calculations? |
A: Current option price is an average of the end of day best bid/ask across all options exchanges:
0.5 * (max(last bid) + min(last ask))
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