Volatility

A brief introduction
What is it?

2
 How is it
measured?

3
Why does
it matter?

4
How does
it behave?

5
Questions

6
What is Volatility?

7
What is Volatility?

Change

8
What is Volatility?

Speed of
Change

9
What is Volatility?

Speed of
Change
Eurostoxx 50 Price

10
What is Volatility?

Speed of
Change
UK Retail Prices Index

11
What is Volatility?

12
What is Volatility?

(Un)predictability

13
What is Volatility?

Uncertainty

14
What is Volatility?

”Fear Index”

15
What is Volatility?

16
How is it Measured?

Not Measured

17
How is it Measured?

Calculated

18
How is it Measured?

Historical
(or Realised)

19
How is it Measured?

Take all the daily

closing prices...

20
How is it Measured?

(Find the log of

daily changes)

21
How is it Measured?

Calculate the
average

22
How is it Measured?

Subtract the
average from each

23
How is it Measured?

Square each result

24
How is it Measured?

Average the
squares

25
How is it Measured?

Take the square

root of the average

26
How is it Measured?

WTF?

27
How is it Measured?

Standardising the
differences

28
How is it Measured?

The Other Kind of

Volatility

29
How is it Measured?

Implied Volatility

30
How is it Measured?

31
How is it Measured?

plus

32
How is it Measured?

Black-Scholes Formula

33
How is it Measured?

equals

34
How is it Measured?

35
How is it Measured?

or even

36
How is it Measured?

37
How is it Measured?

(More about
skew later)

38
How is it Measured?

A Market Price
for Volatility

39
How is it Measured?

Money  Mouth

40
Why does it Matter?

So?

41
Why does it Matter?

Implied Prices

42
Why does it matter?

Money  Mouth

43
Why does it matter?

Circular Argument

44
Why does it matter?

Delta Hedging

45
Why does it matter?

”Investment
Strategy”

46
Why does it matter?

The Option Seller

has a strategy

47
Why does it matter?

”Dynamic
Hedging”

48
Why does it matter?

Sell a
Call Option

49
Why does it matter?

Borrow Money

50
Why does it matter?

Buy Shares

51
Why does it matter?

How Many?
Depends on Delta

52
Why does it matter?

At the Money:
Delta ≈ 0.5

53
Why does it matter?

Buy 1/2 as Many

Shares as Options

54
Why does it matter?

In the Money:
Delta > 0.5

55
Why does it matter?

Buy More Shares

56
Why does it matter?

How Many More?

57
Why does it matter?

Depends on the
Speed of Change

58
Why does it matter?

59
Why does it matter?

60
Why does it matter?

Greater Speed of
Change

61
Why does it matter?

Greater Volatility

62
Why does it matter?

Greater Frequency
of Delta Hedging

63
Why does it matter?

Greater Losses
from Discrete
Delta Hedging

64
Why does it matter?

Losses = Costs
Costs = Prices

65
Why does it matter?

Higher Costs =
Higher Prices

66
Why does it matter?

Higher Prices =
Less Good Stuff

67
Why does it matter?

Questions?

68
Why does it matter?

69
How does it behave?

Term Structure

70
How does it behave?

71
How does it behave?

Why?

72
How does it behave?

Event Impacts

73
How does it behave?

”Buy the rumour,

sell the fact”

74
How does it behave?

Short Term 
More event impact

75
How does it behave?

Long Term 
We’re all dead

76
How does it behave?

Skew (or Smile)

77
How does it behave?

78
How does it behave?

It’s a Smirk, Really

79
How does it behave?

Leptokurtosis: It’s
not a disease!

80
How does it behave?

81
How does it behave?

More extremes
than ”normal”

82
How does it behave?

Extremes 
Speed of Change

83
How does it behave?

Why a Smirk?

84
How does it behave?

Extremes usually
bad ...

85
How does it behave?

86
How does it behave?

Markets never
jump 1000 points

87
How does it behave?

88
How does it behave?

OTM Put Options >

OTM Call Options

89
How does it behave?

90
How does it behave?

Volatility Decay

91
How does it behave?

92
How does it behave?

Volatility rises
quickly ...

93
How does it behave?

FIRE!

94
How does it behave?

... but falls (more)

slowly.

95
How does it behave?

Maybe
not...

96
How does it behave?

Traders have
memories

97
How does it behave?

98
Summary

In summary:

99
Summary

What is it?

100
Summary

A measure
for speed
of change

101
Summary

Derived
from prices

102
Summary

How is it
measured
?

103
Summary

It’s
calculated,
really

104
Summary

Why does
it matter?

105
Summary

It drives
option
prices

106
Summary

How does
it behave?

107
Summary

It slopes...

108
Summary

It smiles...

109
Summary

It decays...

110
Questions

111