Volatility refers to the amount of uncertainty or risk about the size of changes in a security’s value. A higher volatility means that a security’s value can potentially be spread out over a larger range of values. This means that the price of the security can change dramatically over a short time period in either direction. A lower volatility means that a security’s value does not fluctuate dramatically, but changes in value at a steady pace over a period of time.
Volatility is found by calculating the annualized standard deviation of daily change in price. If the price of a stock moves up and down rapidly over short time periods, it has high volatility. If the price almost never changes, it has low volatility. It is a rate at which the price of a security increases or decreases for a given set of returns. It shows the range to which the price of a security may increase or decrease
Significance of volatility ?
- The higher the volatility the harder it is for investors to not worry.
- When certain cash flows from selling a security are needed at a specific future date, higher volatility means a greater chance of a shortfall;
- Higher volatility of returns while saving for retirement results in a wider distribution of possible final portfolio values;
- Price volatility presents opportunities to buy assets cheaply and sell when overpriced
Can volatility be misleading ?
Volatility (standard deviation) can be “gamed”.Investment managers can “game” volatility to make it appear lower than it really is. This can be done in numerous ways, but here are a few: lengthening the measurement period (ex. annualized monthly returns are usually lower than annualized daily returns), writing out of the money options on a portfolio (this can increase returns over many periods before taking a loss, thus hiding underlying risks within a portfolio), infrequent marking to market certain assets, etc.
Volatility is annualized standard deviation of returns. In the traditional theoretical framework, it not only measures risk, but affects the expectation of long-term (multi-period) returns. As such, it asks us to accept the dubious assumptions that interval returns are normally distributed and independent. If these assumptions are true, high volatility is a double-edged sword: it erodes your expected long-term return (it reduces the arithmetic average to the geometric average), but it also provides you with more chances to make a few big gains.
WHAT IS VIX? (MEASURING VOLATILITY)
VIX is the ticker symbol for the chicago board options exchange.Volatility Index, which shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500index options. This volatility is meant to be forward looking, is calculated from both calls and puts, and is a widely used measure of market risk, often referred to as the “investor fear gauge.
India VIX is India’s volatility Index which is a key measure of market expectations of near-term volatility conveyed by NIFTY stock index option prices. This volatility index is computed by NSE based on the order book of NIFTY Options. For this, the best bid-ask quotes of near and next-month NIFTY options contracts which are traded on the F&O segment of NSE are used. India VIX indicates the investor’s perception of the market’s volatility in the near term i.e. it depicts the expected market volatility over the next 30 calendar days. Higher the India VIX values, higher the expected volatility and vice-versa. NSE will also start derivatives based on India VIX. Most probably NSE will come out with India Vix Futures first followed by India Vix options as had been done by the CBOE in the past.