Option IV & HV discussion

[pradipmpatel]

Need some help to understand this subject in detail

 

[deepsa52]

Need some help to understand this subject in detail

There is a good definition of this in schaeffersresearch.com.
# Historical Volatility (HV) - HV is a statistical measurement of a stock's past price movement during a specific time period. Generally, HV is calculated by determining the average deviation from the average price of a financial instrument in the given time period. Stocks with a high historical volatility usually require a higher risk tolerance.
# Implied Volatility (IV) - IV is the estimated volatility of an underlying security's price. It also helps determine the option's price. Since all other factors in the options pricing model are assumed to be known, the implied volatility is calculated last as a plug-in factor after other options pricing components are taken into account. In essence, implied volatilities are driven by market expectations of the underlying stock.
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For a trader who wants to do volatility based trading, what this means is if the IV is low, it makes more sense to purchase a low IV option ( you are paying for the IV ) and /or enter a spread position by selling ( you are receving the IV premium ) the more expensive high IV option" and collecting volatility premium.
For all practical purposes, you would need a software to compare the HV to IV and determine if the option is cheap or not compared to historic values.I am not sure if there is such a tool for retail investor for the Indian Markets.

This is a masterpiece book on the subject, but unfortunately not a very easy to read book.

Option Volatility & Pricing: Advanced Trading Strategies and Techniques (Hardcover) - Sheldon Natenberg