Doc Maher discusses Historical and Implied Volatility.
Pretzel,
Thanks for the kind words. Nicole already addressed this but I wanted to add something. You asked about the 30HV. HV in this case refers to "Historical Volatility". Historical Volatility comes from measuring the stocks actual movement over a time period, in this case 30 days.
The math that is used to determine the price of an option takes into account how "volatile" the stock is. The more volatile a stock is the higher the option price will be because there is a better chance that the stock price will move. The HV is a way to quantify that. However the option price is not set by some formula, it is set by the market. That means that if you use the formula and put in the 30HV you probably would not get the market price. So we have another term called Implied Volatility (IV) that is used instead. IV comes from the actual price of the option and not a theoretical value. So IV is useful as a measure of the current market price of an option and that is why I tend to concentrate on the IV and not the HV.
If the IV is relatively high for that stock as compared to what it usually is, then the option prices are relatively high for the moment. The importance of understanding this is that if the IV drops, the price of the option will drop and if you own one that's not what you want to have happen. So if the IV is high, there is a chance that it will go back to a more "normal" value for a particular stock. When that happens the option vales will drop even if the stock hasn't moved, which will probably make you unhappy.
What makes the IV go up and down? Well things that make the stock more likely to move. For instance, if an earnings announcement is coming there is a higher probability that the stock will move in response to the news. So to compensate for that, the price of the options will rise, and we can see that in IV moving higher. The HV won't be affected because the stock price hasn't moved just the likelihood that it will move has increased.
So let's look at GOOG. Note I hold no positions in GOOG and do not have any opinion on GOOG as an investment.
The IV chart below shows a rapid rise in the IV for GOOG just before earnings announcements for the last several earnings cycles.
Click here for a larger image.
This means that the relative price of GOOG options was rising just before earnings. Notice what happens right after the announcement, the IV drops very quickly, in fact it's like falling off a cliff in many cases. This means that the price of the options dropped very quickly as well. If you bought just before the earnings announcement when the IV was high, you would have paid a relatively high price for the options only to find out the right after the announcement that the relative price had dropped dramatically.
Understanding this is an important step in becoming a better options trader.
I hope this helps,
"Income Trader"
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This comment and any market data included here were prepared on 4/16/08.
Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options.
Any strategies discussed and examples using actual securities and price data are for educational and illustrative purposes only and do not imply a recommendation or solicitation to buy or sell a particular security or to engage in any particular investment strategy. In reading content in the Community, you may gain ideas about when, where, and how to invest your money. Although you may discover new ideas or rationale that may be compelling, you must ultimately decide whether or not to put your own money at risk. Consider the following when making an investment decision: your financial and tax situation, your risk profile, and transaction costs.
The Greeks (Delta, Gamma, Theta, Vega, and Rho) represent the consensus of the marketplace as to the how the option will react to changes in certain variables associated with the pricing of an option contract. There is no guarantee that these forecasts will be correct.
While implied volatility represents the consensus of the marketplace as to the future level of stock price volatility or probability of reaching a specific price point there is no guarantee that this forecast will be correct.
Jonathan F. Maher, PhD. has a professional business relationship with TradeKing.
