Ways To Interpret Volatility


Volatility Crush

If understood volatility is high attributable to Associate in Nursing close at hand event, then it’ll decline when the event, since the uncertainty of the event is removed. This speedy deflation of understood volatility is noted as a volatility crush.

Generally, we tend to observer that understood volatility in choices tends to select up before the company’s result announcement and reduces considerably straight off when the announcement.

Whether the results end up sensible or dangerous, new data is accessible to the market participants that enable the traders to re-value the stock. massive fund homes that have a foothold within the stock tend to shop for place choices before the ends up in order to hedge their positions. They additionally tend to shut out their hedge position simply when the result once the uncertainty is eliminated, leading to a drop by volatility. Unless the corporate announces one thing major or the results sway drastically far from expectation, the volatility within the stock tends to decrease.

Thus, we tend to observe novice traders losing cash by commercialism on the result day even when obtaining the direction correct thanks to factors of understood volatility. the most effective thanks to play the volatility crush is to form possibility methods that tend to learn from a decline in volatility, for example short straddle – that square measure lined below below applications of volatility.

Volatility Surge
It is the precise opposite of a volatility crush. It happens thanks to unforeseen events by the market participants. Panic thanks to such events will cause large spike in volatility, that might even flip your losing position into a winning position. Such a case was ascertained on August twenty four, 2015 once markets tanked from eight,300 to 7,809, a crack of nearly 6 June 1944. it absolutely was the largest fall within the markets when the 2008 crises and also the fourth biggest within the history of the Indian markets.


Generally, it is observed that call option premiums tend to fall when there is a crash in the markets. But on August 24, 2015, something slightly different was observed. Call options that were out of the money witnessed a surge in option premiums to the tune of 50 to 100%.

This phenomenon can be explained due to two factors of option greeks:

Delta: Delta is the amount an option price is expected to move based on one point change in the underlying.

Vega:  Vega is the amount option prices will change, for a corresponding one-point change in implied volatility.

Option GreekImpact of crash on OTM Call options

So when markets cracked on August 24, 2015 call options that were out of the money i.e. strikes 8350 and above that already had a low value of delta witnessed a further decrease in value of delta as markets moved from 8300 to 7809.

While India VIX, a measure of volatility of the entire market, increased to 28% from 17% surging nearly 65% at the close. This unexpected surge in volatility caused the vega component of the out of the money call options to increase sharply.

The combination of a decline in an impact of delta and a surge in volatility caused the vega component to overshadow delta resulting in an unusual price rise in these out of the money call options

Open Interest and Implied Volatility Interpretation

Option TypeO.IImplied VolatilityInterpretation
CallIncreasingIncreasingCall Buying
CallIncreasingDecreasingCall Writing
PutIncreasingIncreasingPut Buying
PutIncreasingDecreasingPut Writing
CallDecreasingIncreasingShort Covering in Call
CallDecreasingDecreasingLong Unwinding in calls
PutDecreasingIncreasingShort Covering in Put
PutDecreasingDecreasingLong Unwinding in Put


VIX stands for volatility index. These volatility indices are measure of market expectation of volatility over a short duration. The first volatility index was VIX introduced at Chicago Board Option Exchange (CBOE).

India VIX

In India, NSE has constructed a volatility index called India VIX. India VIX indicates the investor’s perception of the market’s volatility in the near term. The value is calculated based on the best bid- ask prices of Nifty option contracts. It is an annualized percent figure that estimates the market volatility over the next 30 day time period. The same computation methodology as CBOE is made use of with desired change to reflect the Nifty options order book. Constant fluctuations are witnessed in India Vix values, a high value would imply that market participants expect a significant movement in the price of Nifty while a low value would imply that markets are expected to trade range bound in the near term. Historical data suggest that India VIX and Nifty have shown an inverse relation.

In India future contracts of India VIX are traded. The product allows the trader to

a) Hedge an equity portfolio

b) Take a position based on expected directional movement in volatility

c) Made use of as diversification product in a portfolio

Fear Index

The high level of VIX attracts media attention when the overall stock market is under pressure. Usually the terms fear and greed index are associated with it. The reason for this being the type of option trading that occurs during weakness in the market. When traders are concerned about the direction in the market, they tend to protect their overall position. One common strategy made use of in times of panic is to purchase put options of the Nifty Index. The aggressive purchase of the Nifty put option results in a surge in implied volatility. Hence India VIX, which measures the implied volatility of the Nifty index options, tends to rise when the markets fall and is seen to have an inverse relationship with Nifty.

Volatility Skew

Volatility skew is a result of different implied volatilities for different strike prices of a call or put option. Volatility skew further illustrates that implied volatility depends only on the option premium, not on the volatility of the underlying asset, since that does not change with either different strike prices or option type.

How the volatility skew changes with different strike prices depends on the type of skew, which is influenced by the supply and demand for the different options.

The concept of volatility skew came after the Black Monday 1987 crash in the US markets, before which volatility skew hardly existed. What this means is that if we looked at an option chain, we would see puts and calls equidistant from the current stock price priced nearly the same.

I.e. If Nifty is trading at 10700 an 11000CE would be priced similar to 10300 PE.

After the crash traders soon realize that it was riskier to short put options compared to shorting call options as markets tend to correct with more swiftness than move up. Traders, therefore, started charging a higher premium in order to write put options from the put buyers.

Over the years, as demand for out of the money put options surged in order to hedge the portfolio from frequent market crashes and as put writers charged a premium in order to balance the risk reward, a volatility skew was witnessed resulting in a higher premium for out of the money put options compared to call options.

Reverse Skew/Normal Skew: Is exhibited when out-of-the-money puts are more expensive compared to out of the money call options.

The popular explanation for the manifestation of the reverse volatility skew is that investors are generally worried about market crashes and buy puts for protection. In the Indian markets as well we generally witness a reverse skew as can be seen from the above Nifty option chain.

Nifty 11000 CE is currently trading at Rs 3.40 having a I.V of 8.25%, while Nifty 10300 PE is trading at Rs 12.35 having a I.V of 15.57%; both the option are trading ~400 points from the current market price of 10684.

Forward Skew: Although we normally find puts more expensive than calls, there are instances where the skew reverses as trader’s price calls more expensive than puts. Forward skew is generally witnessed in the commodity market as we often see a surge in commodity prices due to weather and supply demand disruption and as commodities tend to have a floor price. Due to the perceived limited risk, traders are often seen buying more out of the money calls then out of the money put options.

Smiling Skew: A smiling skew is witnessed when there is heavy demand for out of the money options, which result in a surge in implied volatility, which in turn results in out of the money option prices costing more than at the money. This is generally observed before major events such as Election result outcome, Brexit vote etc. where the traders expect heavy volatile in the underlying security without having a specific view on the direction.

Flat Skew means there’s no skew and implicit volatility is that the same for all strike prices; but, this can be hardly witnessed these days.

Options with constant strike costs however with totally different expiration months additionally exhibit a skew, with the way months usually showing a better implicit volatility than the close to months, reflective a bigger demand for far-term choices over those with later expirations.

Vega is one in all the key possibility greeks, it’s live of the impact of changes within the implicit volatility on the choice worth. Vega measures the amendment within the worth of the choice for a amendment within the securities implicit volatility.

Higher the implicit volatility of the choice, higher is that the value related to it. Thus, once implicit volatility surges, the worth of the choice additionally tends to travel higher and equally, once volatility drops, the worth of the choice also will fall.


Reliance Communication is presently commercialism at Rs thirty four and a JAN35 decision possibility is commerce for Rs two.90. Vega for the choice is zero.04

The current implicit volatility for the JAN35 decision possibility is 108%. If the implicit volatility will increase by four-dimensional, then the worth of the choice ought to rise to two.90+0.04*4= Rs 3.06

However, just in case the volatility falls down by 100% to ninety eight, then the choice worth would drop prime to two.9-(0.04*10) = Rs two.5

As seen within the on top of example, despite of no amendment available worth, possibility worth modified severally on account of a amendment in implicit volatility, measured by Vega.

Volatility is often expressed as a positive variety for each for decision and place choices. A put’s possibility worth can increase as implicit volatility will increase within the same manner as a decision choices worth.

Form this instance we have a tendency to clearly see that a surge in volatility tends to profit the customer of the choice and a decline in volatility edges the vendor, provided the {remainder} of the factors remain constant.

Impact of your time and strike worth on Vega

Option premium consists of 2 components price|value|note value|duration|continuance} and intrinsic value. Intrinsic worth could be a live of what proportion the choice is within the cash, whereas the price|value|note value|duration|continuance} is capable the choice premium minus the intrinsic value. Thus, value depends on the chance that the choice can quit of {the cash|the cash|the money} or keep within the money by expiration. Volatility solely affects the value of AN possibility. Therefore, vega, as a live of volatility, is greatest once the value of the choice is greatest and least once value part is little. Since value is greatest once the choice is at the money that’s additionally once volatility can have the very best impact on the choice worth. And even as value diminishes as AN possibility moves additional out of the money or into the money, thus goes vega.