#715 - What Does Realized Volatility Mean?

The "Daily Call" From Option Alpha

Hey everyone. This is Kirk here again from Option Alpha and welcome back to the daily call. Today, we’re going to answer the question, “What does realized volatility mean?” Realized volatility is basically the volatility that actually occurs when you look at historical performance of a stock or an ETF or a security. Now, I relate this very much to paper profits and realized profits. If you have let’s say a position and an underlying security and you’re holding paper profits, but you don’t close it out until tomorrow and after tomorrow, we see a huge move down in the security, well, your realized profit might be lower than what you expected to get. And so, this same thing happens in options trading where we have implied volatility, the expectation that a stock is going to move and then we have realized volatility. You can actually track and see how much the stock actually moved historically relative to its expectation.

This difference is really important because this is where our edge lies as an option seller, this idea that there is an edge or a spread that’s been well-documented between the expected volatility of a security, how much people think it’s going to move and the realized volatility, how much it actually moves. And it’s hard in many cases to see this expectation unless you overlay the charts and the timeframes at the right period. I know in many cases, most broker platforms give you the ability to see historical and implied at the same time, but they’re not overlapping the same time period because implied volatility is always today moving forward which is into the unknown future, into the unknowable space of time beyond today, right? We need to make sure that when we’re looking at realized volatility relative to implied that we overlay the same time periods which is I think a common mistake when many people analyze this. Hopefully this helps out. As always, if you guys have any questions, let us know and until next time, happy trading.