Wednesday, September 9, 2015

Calculating relative implied volatility

Beginning today I've changed how I calculate the relative level of implied volatility.

I measure the relative level as a percentile of a range, and it is the range that has changed.

My prior practice was to calculate the IV level as percentile of the most recent rise. This has proven to be a bit ambiguous, given the fractal nature of an implied volatility chart. Each rise contains rises and falls within it. What counts as the definite range?

My new practice is to calculate the IV level as a percentile of the annual range, lowest low to highest high. The downside is that the period -- a year -- a arbitrary. Why not 90 days, or a year and a half?

So my choice is between ambiguity and arbitrariness. The ambiguous is often a cause of wishful thinking. The arbitrary, while not definitive, is at least very well defined and so promotes rigorous analysis.

I'll take rigor any day of the week.

My preference under the past practice has been to require IV at the 70th percentile or higher. Given the greater range produced in a year, I've lowered that requirement to the 50th percentile or higher.

-- Tim Bovee, Portland, Oregon, Sept. 9, 2015


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Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.
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