Service Navigation

What actually is...Volatility?

Release date: 08 Feb 2013 | Eurex Exchange

What actually is...Volatility?

Volatility - Risks and Chances

Volatility is a highly cited term for market risks. Each and every trader experiences the effects of volatility on a daily basis, making understanding volatility and what it is all about an absolute must for them. Chances and risks are two sides of one coin, because by deliberately integrating volatility into ones trading strategy, one can also exploit its opportunities.
Volatility is a measure for the fluctuation range of a security, a currency or an index and is one of the most important parameters for the price development of an option. Professional investors work intensely with the expected fluctuations of the market, as future price movements decide on profit or loss. High volatility means prices are fluctuating strongly. The higher the expected fluctuation, the higher the likelihood, that the option develops in the investors favor and that a higher price has to be accepted for the particular option. With only low price fluctuations "Vola" goes down as does the price of the option that goes with it.

A distinction is made between historical and implied volatility.
Historical volatility is calculated on the past prices of an underlying asset. It is about the average fluctuation rate of prices, e.g. a stock or an index during a defined time period in the past. The implied volatility is the volatility expected by the market and included in the current price of the option. Is the implied volatility, i.e. the expected fluctuations above the historical volatility, the option will be somewhat more expensive compared to the theoretical price derived from the option-price theory.

Barometer for volatility
Certain indexes are considered barometers for volatility. For example, the VDAX® indicates the implied volatility of the leading German index DAX® over a time period of 45 days in percentage points. A high figure point to an unruly market, whereas lower figures give reason to expect a development without heavy price fluctuations. It does not however give any hints on the direction of the changes, whether they will be rising or falling values.
The VSTOXX® is the benchmark index for the volatility of the European stock market, showing the percentage of the expected volatility in the upcoming 30 days for the EURO STOXX 50® Index.

Investment strategy: turning uncertainty into chances
In market phases like the current developments on the stock markets, the implied volatility is interesting as an asset class of its own. A review shows that in the past volatility often showed a strong negative correlation to the stock markets, implying: falling stock markets mean rising volatility and rising prices lead to less variability.
Almost simultaneously with the falling prices of the European exchange barometer, the VSTOXX®, for example, rises. A direct investment into volatility can therefore effectively be used to diversify a portfolio and also as a safeguard against market shortfalls.
Eurex Exchange offers futures and options on the VSTOXX®, the European benchmark for volatility on the stock market. These products offer precise instruments for investors with a leverage effect to engage in European volatility, providing a simple opportunity to reproduce the expected fluctuation margin of the European stock market in your securities account and to profit from rising volatility.