It is somewhat common knowledge amongst option traders that the CBOE’s Volatility Index ($VIX) can be used as a predictor of forthcoming market movements. In particular, when volatility is trending to extremely low levels – as it is doing now – it generally means that the market is about to explode. In this article, we’ll put some “hard numbers” to that theory and we’ll also look at alternate measures of volatility (QQQ and the $OEX stocks themselves) to see what they have to say.
The question posed in the title above is one that should probably be asked more often than it is. Somehow, it has become something of a consensus in the option trading community that implied and historical (actual) volatility will converge. That’s not really true – at least not in the short term. Moreover, even if they do converge, which one was right to begin with – implied or historical? That is, did implied volatility move to get more in line with actual movements of the underlying, or did the stock’s movement speed up or slow down to get in line with implied volatility? In this article, we’ll look at some examples of what really happens with respect to implied and historical volatility, and we’ll try to draw some conclusions regarding this comparison.
