← InstitutionalLesson 4 · 4:10
Forward volatility and event premia between two expiries
Summary
You can treat each expiry as a block of total variance and pull out the forward volatility priced for the days between two expiries. You can use the same blocks to extract one event day's extra variance and compare the priced move with past moves measured the same way.
Key terms
- total variance
- Volatility squared times the days covered, drawn as a block as wide as the days and as tall as the volatility squared.
- forward volatility
- The volatility priced today for a stretch of days that starts later, found by taking a short expiry's block out of a longer one.
- strip of forwards
- The forward volatilities for each stretch between expiries, laid out as a step line.
- event variance
- The extra variance one day, such as earnings, carries above a normal day, pulled out of two expiries that both hold it.
- priced move
- The size of move the options imply for an event, the square root of that event day's variance.
- root mean square
- Square each past move, average the squares and take the square root, so past moves are measured the same way as variance.
Check yourself
Answer each question to see why the right answer is right.
1. On the real chain, November (18 days) is at about 18% and December (46 days) at about 17%. What volatility is priced for days 18 to 46?
2. Why are the days between November and December priced below both expiries?
3. You compute a forward variance between two expiries and it comes out below zero. What does the lesson's check say?
4. XYZ's 7-day options price 53% and its 14-day options 43%, both holding an earnings day. Solved, a normal day is 30%. The engine prices the 7-day straddle at $5.85 a share, or $3.29 with no event. What does the event add to one contract?
5. The options price a move of about 6% on earnings day. XYZ's last eight earnings moves give just under 5% when squared, averaged and square-rooted. Is selling the event free money?
Finished the video and the quiz? .