| Implied Volatility 101 |
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| 03/04/2005 | |
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Brice Perin, manager of the DWS Convertible Arbitrage fund at DWS Investments, answers this week's 101 on implied volatility. 1-What is the implied volatility? What does it mean? Volatility is a statistical data that measures the standard deviation of an asset's return. It is used to express the risk level as it is perceived by investors. The historical volatility can be computed against various timeframes and frequencies, though it is usually annualised over 252 days. The implied volatility is an anticipation of the volatility to come, based on the market agents' reasons to believe that some factors will modify the behaviour of an instrument or an index. This data is a real asset for some arbitrage funds, which isolate the price of the volatility of a security, for instance an option or a convertible bond, through the use of instruments that hedge the other components of the security. 2-What is the state of the implied volatility on the markets? What is the main trend? The implied volatility has substantially decreased over the last 18 months, and has even reached a 10-year historical low in February. Options on the CAC 40 index were traded at a 40% 3-month implied volatility at the beginning of 2003, against 10% at this time. This low level expresses the investor's faint perception of the capital market risks. Today, the volatility levels reached on short-term and long-term options seem attractive, and in turn represent a good entry point on this asset class. 3-Who are the institutional investors most likely to be interested in this concept? Why? Any investor that is liable to market risks (credit, equity, geopolitical) is likely to be interested in volatility. Furthermore, volatility is in and by itself an asset whose variations have a low, and sometimes negative, correlation with the other assets of a typical investment portfolio. As such, it is a great diversification instrument. Institutional investors have various ways to get exposure to volatility. If an investor gets his exposure through volatility arbitrage funds that use options, he will be more sensible to short-term variations. If he gets it through convertible arbitrage funds, he will be more sensible to long-term variations. But he could also eventually choose funds that are more or less exposed, such as monetary funds or leveraged funds. For insurers, which are particularly exposed to many sources of risk, volatility can be an interesting counterparty. |
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Articles of the same Serie : 101 |
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Articles of the same Topic : Portfolio management |
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