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What is "Volatility"? Which Types of Volatility do we Need to Distinguish?

Volatility is a statistical parameter for price fluctuations of an asset or underlying instrument (a share, for example) over a certain period of time.We can distinguish between historical, expected and implied volatilities.

The historical volatility is a statistical measure used to measure the deviations of an asset‘s price movements from its primary trend, over a certain historic period (e.g. 250 trading days).poe 03 030 060 01

 Volatility is quoted in percent per annum. The higher the volatility, the stronger the price deviations from their average movement within the observed period of time.

Whilst historical volatilities represent a statistical calculation for a period in the past, every option trader needs to estimate the volatility expected for the future.The (expected) volatility in percent must be entered into the option pricing model as one of the factors influencing the option price.
Using a suitable option pricing model, the volatility of an option price can be determined from each option price offered or traded.This so-called „implied volatility“ can be used to assess whether an option is appropriately valued.

 Theoretical option prices can be determined on the basis of option pricing models. Amongst other things, an expected volatility must be entered for that purpose.POE03030060

 

Statisticians have another name for historical volatility: annualized standard deviation. Traders can use historical volatilities to on which to base their own estimation of future volatilities. The higher the entered volatility, the higher the time value and the more expansive the option.

 On the other hand, option pricing models can determine the implied volatility, which is the volatility of a traded option price that lead to this price.POE03030060a

 → The implied volatility may reflect a trader's individual estimation/expectation or his ideas of what the price should be.→ On liquid markets with narrow bid/ask spreads, the implied volatility may also represent the volatility anticipated by the market.The implicated volatility can be calculated from each traded options price which leads to that price. You can make the calculation by using the Eurex OptionMaster by entering the implicated volatility of an options price (here: 8) after calculating a theoretical options price.

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