Explore Your Options by Tom Gentile
What exactly is volatility and how is it
used to trade options? — S.L.
Volatility is simply the rate of change in
a stock, index, or futures contract over a
specific period of time. There are two
types that we are concerned with when
trading options: historical and implied.
When speaking of the movement of the
stock as it has occurred in the past, we’re
referring to historical volatility. After using
a fairly complex formula to calculate
historical volatility, we can use the result
to “guesstimate” where a stock should end
up over the same period of time. Implied
volatility is the market’s assumption of
where the stock is going in the future,
reflected (or implied) in its option price.