Waiting For Godot: Implied Volatility Is Realised Volatility


Implied volatility in the VIX, which is calculated to measure the expected range of movement over the next 30 days, is really mostly backward looking.  In fact, when contrasted with ATR-15 (Average True Range), we find that it is nearly exactly the same.  We consequently use ATR-15 as our realised volatility measurement.

There is some signal value to be gleaned – particularly by spreading realised volatility from implied volatility.  This we call the Realised Volatility Premium.  It is usually negative (or at a discount) — and this makes sense:  this means that options sellers make money in aggregate, and we know this to be true.  When positive (or at a premium), it has been a harbinger of a turning point in the markets.

We theorise this is because the sentiment is overly confident (something options sellers normally are not) when financial conditions change.  This is the market under-estimating something negative.

Despite the fact that we are very concerned about European developments, the Realised Volatility Discount is presently very steep, so the market seems to be “bracing for it”.  When everyone is “bracing for it”, the markets have the tendency to, at least in the short-run, do exactly the opposite of what everyone expects.

Food for thought whilst many of you are waiting for Godot Hurricane Irene.


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2 Responses to Waiting For Godot: Implied Volatility Is Realised Volatility

  1. Rakesh says:

    Great Post! One question: how are you normalizing VIX and ATR-15 to get an apples to apples comparison?

  2. Matt Busigin says:

    Thanks, Rakesh. The answer is that they are very nearly the same thing – which is why you can (perhaps surprisingly) compare them.

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