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15.874 is just the square root of time. 252 trading days in a year will give the expected daily move. (Some peeps adjust here, 16 is commonly used for calcs.)
Wow!!! @WoodyFox thanks a lot!! I have been looking for something like this for months. I once heard Tom Sosnoff mention the "expected move" but I could not figure out how he was computing it. This is extremely interesting!!
I don't know how to thank you enough, also I really appreciate that you find my posts interesting.
If you have any other resources from "the option world" please share them. I would really like to incorporate implied vol. considerations while trading futures.
I have been having the weekly expected move up when trading /ES. It can be a strong support/resistance with confluence. Did not look too deep into other application of IV though. The previous replies are interesting to read. Thank you.
I have been studying this since early last year. From my observations I am confident that levels based on projected ranges have some significance because when we cross those levels you tend to see explosions of volume stopping out. However, the connection between implied volatility and realized volatility is complicated as you can see from the chart. Here I took the expected range of the day plotted against the realized range of the day.
Obviously what point you use for the price of the instrument and the price of your volatility index matters, but my testing did not show statistical significance. This chart was based on using the NYSE opening prices.
Really interesting, thanks for sharing. How were you testing for statistical significance?
I've been inactive here (and trading) for a long time but am considering taking on a big analysis project. Implied volatility and to what extent it can be used as a tool to gauge targets was one of the things that I wanted to look at. Coincidentally have also just read through the thread on orderflow and MBO data you posted in last year as that is probably the other key thing I wanted to explore.
Many strategies can be built on this very premise.
Some traders think this is nothing more than random line theory, but they simple do not get it.
These are high areas of importance statistically. After all, if you know how often they are broke, wouldn't you place a bet.
The connection between implied and realized in nothing more than probability. (Although this may be hard for some to understand and only complicated in that way).
68.2% of the time your range will be within the expected based on one standard deviation.
Use this and a directional filter...Boom you have the basis of a statistical strategy. A place were edges are found. LOL
There is no reason to reinvent the wheel here. JMHO
As for your price point (Control), I would use the prior day close of both. But that's me.
Well it's not a random line. It's the price options are predicting as likely ranges for the day. Whether we do or don't get to that point matter significantly to traders with options positions on.
The connection between implied and realized volatility is a lot more than just probability. That's a gross oversimplification that misses some of the greater insights we get from this data.
Implied volatility and realized volatility aren't very well correlated. Otherwise we would get more of a diagonal line across the chart. Realized volatility tends to underperform implied volatility which is why they cluster on the lower half of the chart. When realized volatility does overperform it can do so substantially creating the randomly scattered points at the top of the chart. However there is also a lower bound meaning that based on implied volatility there is at least some volatility that you can expect creating the empty space below the lines I've drawn on the chart. Periods of low volatility are more common than high volatility creating the huge cluster of points in the bottom left. Most of those points were from 2019 in this image. This year we've had more volatility than normal meaning that if you were relying on that line holding for your trades in 2020 you probably had a pretty bad year.
These are all things that if you're going to trade with volatility should be taken into consideration. Otherwise you'll end up with something that probably makes money overall, but suffers very painful drawdowns and inconsistency. Or rather your risk adjusted returns won't be very good.
Hence will happen 68.2 percent of the time or less. (Looking at one Standard Deviation)
2019 and 2020 are not the same year but they are actually statistically no different.
You can get your straight line.
To do this make your years relevant in terms of a smaller integral.
Look here:
A chart of VXN from Jan. 1 2019 till now. Clearly looks different, but comparing volatility from contract to contract you can see by the bottom plot you get periods of low volatility in 2019 and 2020.
You can do this by comparing Volatility over short periods of time (using IV Percentile, which is used daily by options traders all over the world. Tasty Trade has lots of info on how to use it)
There several other ways to do this...keep that in mind. Just thought I would use something Option traders like.
Here I use 52 Days.
So anything under 50 percentile I would call low volatility relevant to the last 52 days no matter which year you are in.
Capture 10
Also, a high Volatility number just changes the range of the bell curve, it does not change its probabilities.
Capture 11
So just bigger 2020 ranges (implied and realized) with the same statistics behind the connection between them.
You wouldn't be able to compare 2019 to 2020 independently the way you are doing it.
Yes, and the other 31.8% of the time? And what if those all happen in a row? It's more than just the percentage, and you're doing anybody that reads this a disservice by ignoring all nuance. That's how we end up with things like February 2018.
I am talking purely about the statistical properties of implied volatility vs realized volatility. That is the number of days where actual range > expected range is higher than the past. Hence why you see all these retail traders hitting it big with OTM options. I guess I shouldn't have phrased as "we've had more volatility".
But this is why I plotted it on a scatter plot. If you just look at a distribution histogram you don't get the whole story.
Over time will the realized range fall within the expected range, based of implied volatility, 68.2% of the time or less?
If your answer is yes. Good.
If you answer no and can prove it, I will personally enter you for the David Hilbert Award. LOL just sayin.
