Realized vs. Implied Vol

Terry Flanagan

With market volatility on the rise in the weeks leading up to an eventual new United States debt deal, there was a lot of attention paid to the Chicago Board Options Exchange’s VIX index, also known as the market’s ‘fear gauge.’ But there is an alternative measure of market volatility available to investors that offers a different perspective.

The Volatility Exchange was founded in June 2009, and its first product was traded in February 2011.

As of right now, VolX offers just one product, the FX VolContract based on the one-month realized volatility between the Euro and U.S. dollar, which is traded on CME Group’s Globex electronic platform. Since its introduction in February, the average daily volume has been about 10 contracts per day, according to Robert Krause, VolX chief executive officer.

Realized volatility, unlike implied volatility, only tracks the movement of the underlying asset. Regardless of if the underlying went up or down a certain amount, volatility increases. Implied volatility, such as the VIX index, typically has an inverse relationship with the underlying security, so if the underlying goes down, volatility goes up, and vice versa. In addition, the VIX provides a continuous projection of the implied volatility over the following 30 days, whereas realized volatility actually performs a daily measurement of volatility in monthly sectors.

In addition, VolX’s volatility gauge only tracks interday, not intraday, trading, meaning an incident like the May 6 “flash crash” would largely have no effect on the index. Krause asserts that this “opens up a bunch of arbitrage trading strategies that algorithm firms could take advantage of.”

Since March, VolX’s Euro futures VolContract has tracked a steady increase in volatility as each one-month contract settles, ranging from 7.8 for March to 12.13 for July. This is in sharp contrast to the VIX index, which sees drastic swings in short periods of time. Most recently, the VIX rose over 50 percent over the final three weeks of July to a high of about 24 as uncertainty surrounded the U.S. debt situation.

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