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Volatility

A brief introduction

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What is it?

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How is itmeasured?

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Why doesit matter?

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How doesit behave?

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Questions

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What is Volatility?

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What is Volatility?

Change

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What is Volatility?

Speed ofChange

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What is Volatility?

Speed ofChange

Eurostoxx 50 Price

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What is Volatility?

Speed ofChange

UK Retail Prices Index

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What is Volatility?

v

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What is Volatility?

(Un)predictability

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What is Volatility?

Uncertainty

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What is Volatility?

Fear Index

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What is Volatility?

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Not Measured

How is it Measured?

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Calculated

How is it Measured?

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Historical(or Realised)

How is it Measured?

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Take all the dailyclosing prices...

How is it Measured?

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(Find the log ofdaily changes)

How is it Measured?

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Calculate theaverage

How is it Measured?

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Subtract theaverage from each

How is it Measured?

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Square each result

How is it Measured?

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Average thesquares

How is it Measured?

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Take the squareroot of the average

How is it Measured?

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WTF?

How is it Measured?

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Standardising thedifferences

How is it Measured?

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The Other Kind ofVolatility

How is it Measured?

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Implied Volatility

How is it Measured?

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How is it Measured?

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plus

How is it Measured?

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Black-Scholes Formula

How is it Measured?

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equals

How is it Measured?

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How is it Measured?

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or even

How is it Measured?

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How is it Measured?

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(More aboutskew later)

How is it Measured?

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A Market Pricefor Volatility

How is it Measured?

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Money Mouth

How is it Measured?

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Why does it Matter?

So?

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Why does it Matter?

Implied Prices

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Money Mouth

Why does it matter?

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Circular Argument

Why does it matter?

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Delta Hedging

Why does it matter?

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InvestmentStrategy

Why does it matter?

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The Option Sellerhas a strategy

Why does it matter?

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DynamicHedging

Why does it matter?

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Sell aCall Option

Why does it matter?

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Borrow Money

Why does it matter?

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Buy Shares

Why does it matter?

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How Many?Depends on Delta

Why does it matter?

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At the Money:Delta 0.5

Why does it matter?

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Buy 1/2 as ManyShares as Options

Why does it matter?

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In the Money:Delta > 0.5

Why does it matter?

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Buy More Shares

Why does it matter?

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How Many More?

Why does it matter?

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Depends on theSpeed of Change

Why does it matter?

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Why does it matter?

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Why does it matter?

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Greater Speed ofChange

Why does it matter?

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Greater Volatility

Why does it matter?

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Greater FrequencyofDelta Hedging

Why does it matter?

h d ?

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Greater Losses

from Discrete

Delta Hedging

Why does it matter?

Wh d i ?

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Losses = CostsCosts = Prices

Why does it matter?

Wh d it tt ?

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Higher Costs =Higher Prices

Why does it matter?

Wh d it tt ?

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Higher Prices =Less Good Stuff

Why does it matter?

Wh d it tt ?

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Questions?

Why does it matter?

Why does it matter?

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Why does it matter?

How does it behave?

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Term Structure

How does it behave?

How does it behave?

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How does it behave?

How does it behave?

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Why?

How does it behave?

How does it behave?

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Event Impacts

How does it behave?

How does it behave?

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B

uy th

e rumour,sell the fact

How does it behave?

How does it behave?

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Sh

ort Term

Moreevent impact

How does it behave?

How does it behave?

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Long TermW

ereall dead

How does it behave?

How does it behave?

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Skew (or Smile)

How does it behave?

How does it behave?

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How does it behave?

How does it behave?

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Its a Smirk, Really

How does it behave?

How does it behave?

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Leptokurtosis: Itsnot a disease!

How does it behave?

How does it behave?

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How does it behave?

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More extremesthan normal

How does it behave?

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Extremes

Speed of Change

How does it behave?

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Why a Smirk?

How does it behave?

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Extremes usuallybad ...

How does it behave?

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How does it behave?

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Markets neverjump 1000 points

How does it behave?

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How does it behave?

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OTM Put Options >OTM Call Options

How does it behave?

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How does it behave?

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Volatility Decay

How does it behave?

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How does it behave?

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Volatility risesquickly ...

How does it behave?

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FIRE!

How does it behave?

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... but falls (more)slowly.

How does it behave?

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Maybe

not...

How does it behave?

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Tradersh

avememories

How does it behave?

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Summary

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In summary:

Summary

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What is it?

Summary

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A measure

for speedof change

Summary

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Derivedfrom prices

Summary

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How is it

measured?

Summary

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Its

calculated,really

Summary

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Why doesit matter?

Summary

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It drives

optionprices

Summary

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How doesit behave?

Summary

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It slopes...

Summary

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It smiles...

Summary

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It decays...

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Questions