The Curve

by s7ven

The Hedge · Options flow

The Triad

Volatility comes in three tenses. What was realised, what is implied, and what is implied for a period that has not started yet. Confusing them is the most common error in options commentary.

5 terms

Realised volatilityhistorical volatility, RV

The volatility an instrument actually exhibited over a past window, computed from its returns.

Backward-looking and fully observable, unlike implied volatility. The window length is a choice, and a twenty-day and sixty-day figure for the same instrument can tell different stories on the same day.

See also implied volatility
Forward volatility

The volatility implied for a future period, extracted from the difference between two expiries.

If a one-month and a three-month option both trade, the pair implies a figure for the two months in between. It is a derived rate rather than a quoted one, and it inherits the assumptions of the extraction.

Variance risk premiumVRP

The persistent tendency for implied volatility to exceed the volatility subsequently realised.

Usually explained as compensation paid for bearing the risk of a large move. It is a long-run average, not a rule: the periods when it inverts are precisely the periods that matter most.

See also realised volatility
The volatility surface

Implied volatility mapped across every strike and every expiry at once, forming a surface rather than a single number.

Skew is one slice of it across strikes; term structure is the other slice across time. Talking about the implied volatility of an instrument, singular, is always a simplification of this surface.

See also skew and the smile
IV rank and IV percentile

Two ways of expressing where current implied volatility sits relative to its own recent history.

Rank compares against the high-low range of the period; percentile counts how many days sat below the current reading. They can disagree substantially, and neither says anything about what volatility will do next.