9. Realized Volatility Falls, Implied
Volatility Falls
This final volatility-chart permutation incorporates a fall of both realized
and IV. The chart in Exhibit 14.10 clearly represents the slow culmination
of a highly volatile period. This setup often coincides with news of some
scary event’s being resolved—a law suit settled, unpopular upper
management leaving, rumors found to be false, a happy ending to political
issues domestically or abroad, for example. After a sharp sell-off in IV,
from 75 to 55, in late October, marking the end of a period of great
uncertainty, the stock volatility began a steady decline, from the low 50s to
below 25. IV fell as well, although it remained a bit higher for several
months.
EXHIBIT 14.10 Realized volatility falls, implied volatility falls.
Source : Chart courtesy of iVolatility.com
In some situations where an extended period of extreme volatility appears
to be coming to an end, there can be some predictability in how IV will
react. To be sure, no one knows what the future holds, but when volatility
starts to wane because a specific issue that was causing gyrations in the
stock price is resolved, it is common, and intuitive, for IV to fall with the
stock volatility. This is another type of example of reversion to the mean.