Where to find Implied Volatility?

• Your broker
  
  
• Euronext Daily Sheets for UK equity options (Published Euronext’s website) by 6.30pm
  
  
• Note that Technical Analysis software packages such as Metastock by www.Equis.com will be able to calculate historical volatility

Unless you have specialised Option software enabling you determine implied volatility levels your first port of call should be to your broker. He will have quick access to this information but if you find your broker doesn't know what you're talking about, then get one that does. Options are a specialist subject and having a broker who understands them is important.

Guidelines for Volatility

One of the most important facts about volatility is that it will always, at some stage in the future, revert to its mean.

Therefore it never stays high or low indefinitely. Also realise that markets and individual shares do change in character overtime and therefore historic levels of high and low volatility can change over several years.

An example of this would be UK equities from 1990-1995 and then 1996 to present. What was considered a high volatility reading for a share pre 1994 may well now be considered fairly valued.

You must also be aware that one reading of volatility is useless unless you find the range of what is perceived to be expensive or cheap. It is therefore worthwhile to have this information at hand.

For an important market such as the FTSE 100, the ranges of volatility shown below should be common knowledge for option practitioners.

But what about finding the necessary information for a market or stock that you've never traded before? This is where your broker will come in. A quick phone call is all that's needed and the information that you're looking for is simple, just ask -

"Where is the current volatility for BP. And what are the levels at which it is considered cheap or expensive"

Volatility Guideline for FTSE 100

• Cheap - Under 15%. 10% historically very cheap
• Fairly Valued - 15% - 30%
• Expensive - Over 30% (Sep/Oct 2001 volatility peaked at over 70%)

How to Use Volatility In Your Trading?

In a general sense volatility moves higher as prices on the underlying decline. And therefore as prices move higher volatility will move lower.

Basically most markets go down far quicker than they move up. Or to look at it another way, as price goes down price becomes far more unstable and this is what the essence of volatility is all about.

When trading or dealing options volatility should be your road map. If volatility is high then different strategies should be considered compared to when it is low. This translates to mean, look to buy options or option strategies when volatility is low and look to sell short options/strategies when it is historically high.

To me, the worst thing that anyone can do is buy options when volatility is high and I remind you to read the example on this page for a detailed explanation.

Summary on Volatility

Ignore this topic at your peril when dealing in options. A large majority of retail traders who deal in options haven't heard of volatility, yet alone understand it. And this group then complain why strange things happen to their positions.

The strange moves are normally down to volatility moving thus inflating or decreasing option premiums, regardless of whether the stock or market is going up or down.

To make money in options you therefore can't just rely on your view on the underlying security. You have to also think about not only the level of volatility today, but also what it's likely to do in the future.

But as I’ve said before, to understand volatility and use it to your advantage doesn't have to be hard.

An example of a simple rule to incorporate into your trading plan would be to never buy options when volatility is at historically high levels and never sell short options when at historically low levels. Look at this example of the problems that can result when buying options with high volatility premiums.

Whatever your trading scenario or plan, the power and significance of volatility has to be respected.