3. Realized Volatility Rises, Implied
Volatility Falls
This chart pattern can manifest itself in different ways. In this scenario, the
stock is becoming more volatile, and options are becoming cheaper. This
may seem an unusual occurrence, but as we can see in Exhibit 14.4 ,
volatility sometimes plays out this way. This chart shows two different
examples of realized vol rising while IV falls.
EXHIBIT 14.4 Realized volatility rises, implied volatility falls.
Source : Chart courtesy of iVolatility.com
The first example, toward the left-hand side of the chart, shows realized
volatility trending higher while IV is trending lower. Although
fundamentals can often provide logical reasons for these volatility changes,
sometimes they just can’t. Both implied and realized volatility are
ultimately a function of the market. There is a normal oscillation to both of
these figures. When there is no reason to be found for a volatility change, it
might be an opportunity. The potential inefficiency of volatility pricing in
the options market sometimes creates divergences such as this one that vol
traders scour the market in search of.
In this first example, after at least three months of IV’s trading marginally
higher than realized volatility, the two lines converge and then cross. The