800 Part VI: Measuring and Trading Volatility 
of success. If it turns out that volatility is higher during the life of the position, that 
will be an added benefit to this position consisting of long options. So, in this exam­
ple, he should use the 20-day historical volatility because it is the lowest of the four 
choices that he has. 
Similarly, if one is considering the sale of options or is taking a position with a 
negative vega ( one that will be harmed if volatility increases), then he should use the 
highest historical volatility when making his probability projections. By so doing, he 
is again being conservative. If the strategy in question still looks good, even under an 
assumption of high volatility, then he can figure that he won't be unpleasantly sur­
prised by a higher volatility during the life of the position. 
There have been times when a 100-day lookback period was not sufficient for 
determining historical volatility. That is, the underlying has been performing in an 
erratic or unusual manner for over 100 days. In reality, its true nature is not described 
by its movements over the past 100 days. Some might say that 100 days is not enough 
time to determine the historical volatility in any case, although most of the time the 
four volatility measures shown above will be a sufficient guide for volatility. 
When a longer lookback period is required, there is another method that can be 
used: Go back in a historical database of prices for the underlying and compute the 
20-day, 50-day, and l 00-day historic volatilities for all the time periods in the data­
base, or at least during a fairly large segment of the past prices. Then use the medi­
an of those calculations for your volatility estimates. 
Example: XYZ has been behaving erratically for several months, due to overall mar­
ket volatility being high as well as to a series of chaotic news events that have been 
affecting XYZ. A trader wants to trade XYZ's options, but needs a good estimate of 
the "true" volatility potential of XYZ, for he thinks that the news events are out of the 
way now. At the current time, the historical volatility readings are: 
20-day historical: 130% 
50-day historical l 00% 
100-day historical 80% 
However, when the trader looks farther back in XYZ's trading history, he sees 
that it is not normally this volatile. Since he suspects that XYZ's recent trading histo­
ry is not typical of its true long-term performance, what volatility should he use in 
either an option model or a probability calculator? 
Rather than just using the maximum or minimum of the above three numbers 
(depending on whether one is buying or selling options), the trader decides to look