Monday, December 26, 2011

"increase in volatility" can mean 1 of 2 things

An "increase in volatility" actually can mean 2 different things.

@ increase in "historical volatility", which actually means increase in recent, observed volatility on the Cash market.[1] I feel this is what "increase in volatility" usually means.
@ increase in implied volatility, reflected in higher bid/ask "insurance" premiums on the Options market.

I-vol is forward-looking and refers to predicted future volatility of an underlier (like SPX) over the next 30 days (or 90, or 365 ... days). So an increase there reflects people's anticipation of market volatility.

H-vol is backward-looking and refers to recorded, realized volatility of an underlier (like GBP) over the past few days. When people talk about increase in h-volatility, I believe it's usually over the Recent past.

[1] if you have an option on futures, then it's not the Cash market but the futures market, but in this context it's better to remove this kind of noise and focus on simple concepts.

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