Understanding Volatility

Volatility is a statistical measure of the amount of fluctuation in a stock’s price within a period of time. A stock with high volatility would have rapid up and down movements in its stock price. A stock with very little movement in its price would constitute low volatility. There are two main measures of Volatility: Historical Volatility & Implied Volatility. Historical volatility will be discussed in this report whereas implied volatility will be explained in the subsequent report.

Historical Volatility
  • Historical Volatility is a statistical measure of the volatility of a futures contract, security, or other instrument over a specified number of past trading days
  • Historical volatility is the measure of a stock’s price movement based on historical prices. It measures how active a stock price typically is over a certain period of time. Usually, historical volatility is measured by taking the daily (close-to-close) percentage price changes in a stock and calculating the average over a given time period. The average is then expressed as an annualized percentage. Historical volatility is often referred to as actual volatility or realized volatility
  • Short-term or more active traders tend to use shorter time periods for measuring historical volatility, the most common being 5-day, 10-day, 20-day and 30-day. Intermediate-term and long-term investors tend to use longer time periods, most commonly 60-day, 180-day and 360-day
Implied Volatility
  • Implied Volatility can be defined as the volatility of an instrument as implied by the prices of an option on that instrument, calculated using an options pricing model. An option’s value consists of several components – The strike price, expiration date, the current stock price, dividends paid by the stock (if any), the implied volatility of the stock and interest rates
  • Instead of substituting a volatility parameter into an option model (e.g. Black-Scholes) to determine an option's fair value, the calculation can be turned round, where the actual current option price is input and the volatility is output. Therefore implied volatility is that level of volatility that will calculate a fair value actually equal to the current trading option price
  • This calculation can be very useful when comparing different options on the same underlying & different strike prices. The implied volatility can be regarded as a measure of an option's "expensiveness" in the market, and is used by traders setting up combination strategies, where they have to identify relatively cheap and expensive option contracts
  • As there are many options on a stock, with different strike prices and expiration dates, each option can, and typically will, have a different implied volatility. Even within the same expiration, options with different strike prices will have different implied volatilities
  1. What is online trading in securities?

    Online trading in securities refers to the facility of investor being able to place his own orders using the internet trading platform offered by the trading member viz., the broker.
    The orders so placed by the investor using internet would be routed through the trading member

  2. How can one start trading online?

    To start with, investor needs to identify a trading member who offers internet trading facility and register with the trading member for availing the internet trading facility

  3. Who could use online trading?

    Usually, a person familiar in using computer, conversant with the use of internet and who is able to tackle routine problems associated with use of personal computers may opt for online trading

  4. Are there additional documents to be executed for registering as internet customer?

    As per SEBI and Exchange stipulations, in addition to execution of regular KYC documents, the investor would have to execute a specific Member- client agreement for internet trading which broadly spells out the rights and obligations of trading member and Investor besides alerting on system related risk, confidentiality of user id and password

  5. What documents are received usually after registration as an online trading client?

    On registering as online trading client with the trading member, normally investor receives a welcome kit containing the user-id and password allotted to the client

  6. What precautions an online investor must take on starting online trading?
    1. The Default password provided by the broker is changed before placing of order. Ensure that password is not shared with others. Change password at periodic interval
    2. He has understood the manner in which the online trading software has to be operated.
    3. He has received adequate training on usage of software
    4. The system has facility for order and trade confirmation after placing the orders
  7. What should investor know about failure of system that is being used for placing orders?

    Every online trading client should understand that there could be a possibility of failure of system which could include failure at various points including net work failure, connectivity failure etc.

  8. What are the other safety measures online client must observe?
    1. Avoid placing order from the shared PC’s / through cyber cafés
    2. Log out after having finished trading to avoid misuse..
    3. Ensure that one does not click on “remember me” option while signing on from non-regular location.
    4. Do not leave the terminal unattended while one is “signed-on” to the trading system
    5. Protect your personal computer against viruses by placing firewall and an anti-virus solution.
    6. You should not open email attachments from people you do not know
  9. How can one investor make sure that his access to trading is continuously available?

    In the course of his dealing, investor should always make sure that sufficient funds and securities are available in his account with the trading member and that he is regular in payment of margins so as to avoid blocking of account by the trading member.

  10. Where online trades are being done is there any documents that I need to receive from the trading member for the trades executed?

    For every trade that takes place on the Exchange, the trading member needs to issue contract note within 24 hours from the date of execution of the trade. Generally, internet based investors opt for Digital contract notes. Hence, at the time of client registration investor should provide an email id which is regularly used.
    In case investor wishes to receive physical contract notes, he may specify so in the client registration document and cut off the email id column.
    Investor needs to regularly check the contract notes and if any variation in the trades is found needs to take up the issue with the trading member immediately.
    Besides the Contract Notes, trading member needs to issue quarterly statement of funds and securities to the investor and such statement can be digitally issued if investor has opted for digital document.

Live chat