How Do Volatility Cones Help a Trader Compare IV and HV?
Volatility cones are graphical tools used by options traders to visually compare an asset's implied volatility (IV) against its historical volatility (HV) across different time horizons. The cone plots the range of historical volatility (e.g. the 10th to 90th percentile) for various lookback periods.
A trader can then plot the current IV curve onto the cone. If the IV curve is above the historical range, it suggests options are relatively expensive; if it's below, they are cheap.
This helps assess whether current option prices are over- or undervalued relative to past realized volatility.
Glossar
Volatility Cones
Calibration ⎊ Volatility cones represent a probabilistic assessment of future implied volatility, derived from current options market data and projected forward in time, offering a visual depiction of potential volatility surface evolution.
Volatility Cone
Visualization ⎊ The volatility cone is a graphical tool used in options analysis to visualize the range of historical realized volatility for an underlying asset over different time horizons.
Historical Volatility
Evidence ⎊ This metric is derived from the time-series of past asset prices, representing the actual realized dispersion of returns over a defined historical window.
Implied Volatility
Expectation ⎊ This value represents the market's consensus forecast of future asset price fluctuation, derived by reversing option pricing models using current market premiums.
IV Curve
Structure ⎊ This term describes the graphical representation of implied volatility plotted against both the option's strike price and its time to expiration, forming a three-dimensional surface.