6. Realized Volatility Remains Constant,
Implied Volatility Falls
Exhibit 14.7 shows two classic implied-realized convergences. From mid-
September to early November, realized volatility stayed between 22 and 25.
In mid-October the implied was around 33. Within the span of a few days,
the implied vol collapsed to converge with the realized at about 22.
EXHIBIT 14.7 Realized volatility remains constant, implied volatility falls.
Source : Chart courtesy of iVolatility.com
There can be many catalysts for such a drop in IV, but there is truly only
one reason: arbitrage. Although it is common for a small difference between
implied and realized volatility—1 to 3 points—to exist even for extended
periods, bigger disparities, like the 7- to 10-point difference here cannot
exist for that long without good reason.
If, for example, IV always trades significantly above the realized
volatility of a particular underlying, all rational market participants will sell
options because they have a gamma/theta edge. This, in turn, forces options
prices lower until volatility prices come into line and the arbitrage
opportunity no longer exists.
In Exhibit 14.7 , from mid-March to mid-May a similar convergence took
place but over a longer period of time. These situations are often the result