Calculating Options Volatility

In the Vanilla Options Toolbox video, we talked about volatility as a moving target. The chart above is the CBOE NASDAQ Volatility Index, called the VXN. The chart is one year of daily data, and you can see that indeed volatility is a moving target that ranged from around 15 all the way up to about 34.

Using the Black-Scholes option pricing formula, that extreme range of values would produce a rather huge range in stock prices and option prices, possibly wreaking havoc on your call or put buying strategy. Anybody who bought long, out-of-the-money options at the apex of volatility almost certainly got killed when volatility dropped and their out-of-the-money options went immediately to pennies.

In the Options Toolbox, we have a screen that does implied volatility calculations, but perhaps another way to handle the volatility calculation is to use an index like the VXN. If not for assigning voaltility then to try to get a handle on the direction in which volatility is heading. One thing that we did with this chart was that we put the VXN data into Excel and ran a trendline through the data, and then projected the data ahead 30 days. It looks like a fairly good estimation that volatility will creep higher into the February expiration period.