Implied vs historical volatility: what's the difference?

What is implied volatility?

Volatility measures price movements over a specified period.

A highly volatile stock is one that has large swings in price, whereas a low volatility stock has a more stable price. As an example, a stock that trades between $20 and $40 would be considered more volatile than another that trades between $25 and $30. For the comparison to be meaningful, however, both must be measured over the same period.

Implied volatility, often referred to as projected volatility, is simply an estimation of the future volatility of a stock or index, based on option prices. Implied volatility tends to increase in bearish markets, which is when investors believe equity markets are likely to decline. This is due to these market conditions being considered ‘riskier’ for most investors.

It’s important to note that implied volatility is not an exact science - it’s a forward-looking calculation that allows investors to estimate where the market is headed.

How is historical volatility calculated?

Unlike implied volatility, historical volatility (as the name suggests) is backward looking and is calculated using the variability of prices that are already known.

Historical volatility does not consider market direction -- rather, it looks at how far a price deviates from its average value, up or down, within a specified period.

Historical volatility is the average deviation from the average price of a security, expressed as a percentage, and is useful when comparing it with other stocks or indices. The higher the percentage, the higher the volatility, and thus the ‘riskier’ the security is perceived to be (and vice-versa).

When a security’s historical volatility is rising, or is higher than usual, this means prices are moving up and down to a greater degree and/or more quickly than usual. This tells investors that the market expects something to change, or that something to do with the security has already changed.

Investors in stocks with a high historical volatility tend to have a higher risk tolerance - but of course, a stock having a higher historical volatility than another is not necessarily a bad thing, as risk can mean better returns for investors too.

This document is issued by FIL Responsible Entity (Australia) Limited ABN 33 148 059 009, AFSL No. 409340 (“Fidelity Australia”).  Fidelity Australia is a member of the FIL Limited group of companies commonly known as Fidelity International.

Investments in overseas markets can be affected by currency exchange and this may affect the value of your investment. Investments in small and emerging markets can be more volatile than investments in developed markets.

This document is intended for use by advisers and wholesale investors. Retail investors should not rely on any information in this document without first seeking advice from their financial adviser. This document has been prepared without taking into account your objectives, financial situation or needs. You should consider these matters before acting on the information.  You should also consider the relevant Product Disclosure Statements (“PDS”) for any Fidelity Australia product mentioned in this document before making any decision about whether to acquire the product. The PDS can be obtained by contacting Fidelity Australia on 1800 119 270 or by downloading it from our website at www.fidelity.com.au. This document may include general commentary on market activity, sector trends or other broad-based economic or political conditions that should not be taken as investment advice. Information stated herein about specific securities is subject to change. Any reference to specific securities should not be taken as a recommendation to buy, sell or hold these securities. While the information contained in this document has been prepared with reasonable care, no responsibility or liability is accepted for any errors or omissions or misstatements however caused. This document is intended as general information only. The document may not be reproduced or transmitted without prior written permission of Fidelity Australia. The issuer of Fidelity’s managed investment schemes is FIL Responsible Entity (Australia) Limited ABN 33 148 059 009. Reference to ($) are in Australian dollars unless stated otherwise. 

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