Isn t Implied Volatility better than Historical Volatility?
Most currency and commodity option dealing desks rely very heavily upon the volatility implied by the actual trading levels of currency and commodity option premiums for the pricing, risk management and pursuit of profit in their currency option books. • This “implied volatility” is obtained by simply “re-writing” standard option valuation models to a) utilize the current pricing level of a specified option contract as a model input, and to b) produce a consequent “implied volatility” as output. • If this process is undertaken for a particular European-style option contract that is priced “at the money”, (where the exercise price of the option is equal to the current forward rate), a case can be made that the “indirect” volatility thus implied can be considered as a legitimate alternative to the directly-measured volatility of the underlying currency. • Furthermore, implied volatility is considered to “forward-looking”, in that it is a measure of market expectations for the exchange ra
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