Historical volatility describes the price movement of an underlying security in the past. Learn how historical volatility is calculated and how you can use it in your trading.

Hey everyone. This is Kirk here again at Option Alpha and in this video, we are going to go through historical volatility and just basically answer the question, “What is historical volatility? How can we potentially use it? How is it derived?” And one thing you have to understand about historical volatility is that it really should be called… Even though historical makes some sense in many cases, but it’s really statistical volatility that we see. I think of it as actually, statistical volatility which is – this is the volatility that we actually see in the market going back in time. A lot of people use historical because it’s backward-looking in its history. I think statistical is the more appropriate way to think about it because it is truly that. It’s just a statistic that we can use as a basis and a framework for what we might do or how we might think about options or the security moving forward.

You basically have two things going here at the same time. One, you have the stock which is just trading in its range and moving up and down, all the way until today. It could be going in a zigzag fashion. It could just be simply trending and just continuing to move straight upward as it moves forward in time. And as the stock continues to move, we calculate or broker platforms calculate this moving average of backward-looking historical volatility. And basically, what it’s doing is it’s taking a snapshot in time and it’s saying, “Okay. Between this point here and this point here, how much statistical volatility did this security experience? Was there a lot of movement between this point and this point or did it have very little movement?” In the case of this particular stock which is the more-jagged and volatile one, between these two data points, this stock had a lot more statistical volatility, moved a lot more than this stock here which just went on a very simple upward sloping trend. And then what they do is they take that and they graph that line down here to show statistical volatility going back in time. And so, what we can do as traders, is we can take today’s data point and look backwards and see how much volatility the stock has experienced between today’s price now, so today and whatever point we’re looking back at in the future. And so, this data point here tells us that, “Okay. From today back, maybe we’ve seen 10% historical volatility in the stock.” or maybe we’re looking at a stock that has gone through a lot more volatility up and downs historically and maybe the historical volatility on this stock is 15% from today back to the beginning of that chart.

Now, what’s interesting to me is that this really doesn’t do anything for us to project what might happen in the future. A lot of people incorrectly use historical volatility to suggest that if there is high volatility in the past, there’s going to be high volatility moving forward. But guess what? We have no idea what’s going to happen moving forward. This is where we talk about implied or expected future volatility expectations in other videos. What you should understand at this point is that historical volatility is just a data point that we can look at to make some assumptions about where things have been and where they might go in the future, but that definitely doesn’t mean that a stock can then change direction or couldn’t change direction. And in this case, the one that’s really jagged becomes very, very flat after today, so for some reason, just starts trading absolutely sideways and the one that seem like it had really low historical volatility starts trading all over the place as it moves forward. Anything can happen from today forward, but again, this historical volatility just tells us how volatile the stock has been in the past.

Two things that you could look at for historical volatility are not only just the reading itself which we’ve covered here, but the other thing you can look at is you can look at the changes in different volatility ranges. If we actually track volatility going back 30 days, we might see that a stock has 25% volatility over the last 30 days. If we go back 180 days, we might actually see that that same stock has 45% statistical or historical volatility over the last 180 days. Now, that to me is significant because that might suggest that the stock is starting to calm down and is maybe not trading as aggressive or as volatile as it had previously in the last 180 days. If I see something where the 30 day volatility is really low, but the 180 day volatility is actually much higher, I might assume or I might prepare myself to expect the stock to be more volatile moving forward, more in line with its more longer term average. Again, this can happen in reverse where you see implied volatility on the front 30 day or 60 day or 10 day. You can do it a bunch of different ways. There’s no real right way to do it or wrong way to do it. But you might see implied volatility on the 30 days of 45% and you might see implied volatility over the last 180 days of only 10%. And so, this would suggest, “Whoa! There’s something happening that’s been happening recently. The stock has been really, really volatile. Did something change with the company? Did something change with the industry, your sector? This thing is usually a lot more calmer.” That doesn’t mean it’s not going to be more volatile or won’t end its volatility and be calm moving forward, but again, it’s just an interesting data point to see where those different changes are in historical volatility. As always, hopefully this helps out. If you have any other questions, let us know and until next time, happy trading.

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