MEANING OF VOLATILITY

In finance, volatility is a measure for variation

of price of a financial instrument over time.

Historic volatility is derived from time series

of past market prices.

In other words, volatility refers to the

amount of uncertainty or risk about the size

of changes in a security's value. This means that the price of the security can

change dramatically over a short time period

in either direction.

It is used to quantify the risk of the financial instrument over the specified time period. Volatility is normally expressed in annualized terms, and it may either be an absolute number ($5) or a fraction of the mean (5%).

 Actual Historical: volatility which refers to the

TYPES

volatility of a financial instrument over a specified

period but with the last observation on a date in the

past
Actual Future: volatility which refers to the volatility

of a financial instrument over a specified period starting at the current time and ending at a future date (normally the expiry date of an option).

Current Implied Volatility :

which refers to the implied volatility observed

from current prices of the financial instrument Future Implied Volatility :

which refers to the implied volatility observed

from future prices of the financial instruments.

Volatility for investors

When certain cash flows from selling a security are

needed at a specific future date, higher volatility means a greater chance of a shortfall.
Price volatility presents opportunities to buy assets

cheaply and sell when overpriced.

In today's markets, it is also possible to trade volatility

directly, through the use of derivative securities such as options.

Volatility versus direction

Volatility does not measure the direction of price

changes, merely their dispersion.

This is because when calculating standard deviation (or

variance), all differences are squared, so that negative

and positive differences are combined into one quantity.

For example, a lower volatility stock may have

an expected (average) return of 7%, with annual

volatility of 5%. This would indicate returns from approximately

negative 3% to positive 17% most of the time

(19 times out of 20, or 95% via a two standard

deviation rule)

Measures
There are several used measures of volatility, some

examples:

Range (maximun value - minimun value)

Crude volatility estimation

Using a simplification of the formulas above it is

possible to estimate annualized volatility based solely on approximate observations.

Suppose you notice that a market price index, which

has a current value near 10,000, has moved about 100 points a day, on average, for many days. This would constitute a 1% daily movement, up or down.

V o l a t h " .

Volatility is a poor measure of risk, as explained by Peter Carr, "it is only a good measure of risk if you feel that being rich then being poor is the same as being poor then rich".