Basic Module 7 – Volatility

Introduction / Learning Outcomes:

Open a virtual trading account to practice what you pick up in each module

Kevin Cook takes you through the foundation of options trading – volatility. “Volatility is your best friend in options trading…” Kevin walks you through the general definition of volatility, how to calculate volatility, how to compare volatility against different stocks and time periods to get a better read on the stock, future volatility and the mythical implied volatility. Specifically, you shall learn:

1. A general definition of volatility.
2. How volatility is used in options pricing.
3. How standard deviation is used as volatility.
4. How probability can put profits in your pockets.
5. How to interpret a volatility reading.
6. Why the options market uses volatility to determine the future.
7. How volatility is the speed in which an option reaches a price.
8. The definition of historical volatility.
9. How traders use future volatility.
10. How option market makers use forecast volatility.
11. Where implied volatility is generated.
12. How each volatility generates a unique price in the Black-Scholes option-model.
13. Why implied volatility describes an options risk.
14. How to trade options using implied volatility.

Recommended Exercises:

1. Calculate the standard deviation of a stock’s monthly returns for the past year.
2. Calculate the standard deviation of another stock’s monthly returns for the past year.
3. Compare the standard deviations of both and determine which stock is more volatile.
4. Using the first stock, calculate the standard deviation of the stock’s monthly returns for two years.
5. Compare the standard deviations between the stocks using one year and two years. Compare if the stock has increased volatility, decreased volatility or remained the same.
6. Look at three stocks priced similarly. Calculate the standard deviation of each. Add each of the stock prices with their standard deviation respectively. Compared which stock is predicted to move the most and the least.

Find the implied volatility for an option.