Implied volatility (IV) is used to estimate the expected daily price range of an underlying asset. It reflects the market's expectation of how much the price of an asset will fluctuate in the future. To determine the expected daily range, you can convert the annualized implied volatility to a daily figure using the square root of 1/252 (assuming 252 trading days in a year). Then, you can multiply this daily implied volatility by the current asset price to get the expected daily price range.
Understanding Implied Volatility:
Implied volatility is derived from the price of options and represents the market's expectation of how much the price of the underlying asset will move. It's not a prediction of price direction, but rather a measure of expected price fluctuation. Higher implied volatility suggests a wider expected range, lower implied volatility a narrower expected range.
Calculating the Expected Daily Range:
Current price * Annualized implied volatility * Square root of 1/252
Implied volatility is typically quoted as an annualized percentage. To estimate the daily expected price move, you need to convert the annualized IV to a daily figure. This is done by dividing the annualized implied volatility to a daily figure using the square root of 1/252. Once you have the daily implied volatility, you can calculate the expected daily price range. Multiply the current price of the underlying asset by the daily implied volatility. For example, if the daily implied volatility is 20% and the current price is $5000, the expected daily range is 63.
Using Standard Deviations:
The calculated daily range can be further interpreted using standard deviations. One standard deviation (1 SD) represents approximately a 68% probability that the price will stay within that range. Two standard deviations (2 SD) represent a 95% probability, and three standard deviations (3 SD) represent a 99.7% probability. For example, if the expected daily range is 63 (1 SD), then there is a 68% chance the price will stay within 63 range.
