31 lines
2.0 KiB
Plaintext
31 lines
2.0 KiB
Plaintext
Should HV and IV Be the Same?
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Most option positions have exposure to volatility in two ways. First, the
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profitability of the position is usually somewhat dependent on movement
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(or lack of movement) of the underlying security. This is exposure to HV.
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Second, profitability can be affected by changes in supply and demand for
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the options. This is exposure to IV. In general, a long option position
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benefits when volatility—both historical and implied—increases. A short
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option position benefits when volatility—historical and implied—decreases.
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That said, buying options is buying volatility and selling options is selling
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volatility.
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The Relationship of HV and IV
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It’s intuitive that there should exist a direct relationship between the HV and
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IV. Empirically, this is often the case. Supply and demand for options, based
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on the market’s expectations for a security’s volatility, determines IV.
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It is easy to see why IV and HV often act in tandem. But, although HV
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and IV are related, they are not identical. There are times when IV and HV
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move in opposite directions. This is not so illogical, if one considers the key
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difference between the two: HV is calculated from past stock price
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movements; it is what has happened. IV is ultimately derived from the
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market’s expectation for future volatility.
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If a stock typically has an HV of 30 percent and nothing is expected to
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change, it can be reasonable to expect that in the future the stock will
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continue to trade at a 30 percent HV. By that logic, assuming that nothing is
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expected to change, IV should be fairly close to HV. Market conditions do
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change, however. These changes are often regular and predictable. Earnings
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reports are released once a quarter in many stocks, Federal Open Market
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Committee meetings happen regularly, and dates of other special
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announcements are often disclosed to the public in advance. Although the
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outcome of these events cannot be predicted, when they will occur often
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can be. It is around these widely anticipated events that HV-IV divergences
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often occur. |