If you want to know as much as you can about options trading, it is important that you do your research prior to getting started because there is a lot of invaluable information online. A good place to start would be looking up the definitions of different terms that relate to these types of investment opportunities.
In particular, you may want to know what historical volatility is as well as how it is used in options trading. With that being said, here is some information that will explain a little bit more about what historical volatility entails.
What is Historical Volatility?
Historical volatility can be can be explained in a number of different ways. In fact, some people may refer to it as the realized volatility of a financial instrument over a given time period.
Generally, this measure is calculated by determining the average deviation from the average price of a financial instrument in the given time period. Standard deviation is the most common but not the only way to calculate historical volatility.
Similar to a vehicle traveling down the road at a specific mile per hour, the same comparison can be made with historical volatility. In this situation, however, the rate of change is compared to an annual scale versus per hour.
Even though the trader may not know in which direction that they can expect the changes, the rate of change will be the same with future options. Therefore, certain measurements can be made in advance for the future. For example, if the volatility is considered to be too high, the price of these options are also considered to be high.
On the other hand, if the volatility is known to be low, the price of these options will also reflect a low premium. In either case, you will have some formal strategy that you can use to make the best decisions possible.
How Historical Volatility is Used in Option Trading
Historical volatility is a great measurement to use when getting started and as time passes by. With this measurement, each person has a chance to carefully assess their needs before trading.
When this measurement is considered, it will help traders with determining the best option pricing available and what type strategy would work best.
For instance with volatility in consideration it’s better to be a seller of options to collect the higher premium while being a buyer with volatility is lower and the premium’s are cheaper.
Trading options can be very complex as there are so many different ways you can trade them. The most important thing to remember is, like anything in trading, to take it slow and start with small size or even in a simulator.
Options are leveraged assets which means you can lose a lot quickly.
Let us know if you have any questions in the comments below!