Question

a. What is historical volatility? What is implied volatility? How to interpret the situation if you observe that historical volatility is lower than implied volatility?

b. Why is the distinction between investment and consumption assets important in the determination of forward and futures prices? On 20th April, 2020, the future contracts for May delivery of West Texas is minus $37.63 a barrel, how to explain the negative future price using the knowledge acquired from this course?

Answer 1

Historical volatility is the votality or variation in the stock price over a period of time, ie. Standard deviation as a percentage of stock prices historically. It is like looking backward approach. Implied voatility on the other hand is the future oriented approach, which calculates voltality on the basis of Option prices. For both types of voltality, the basic rule is same, higher the value, higher will be the variation. However, if the implied voltality is less than historical voltality, it means option price are less than their implied premium or selling at discount.