Estimating Futures Volatility from Returns or Price Changes
Summary
The post compares two ways to estimate volatility: standard deviation of percentage returns and standard deviation of absolute price changes. For futures, it recommends forming percentage changes with back-adjusted price differences in the numerator and the current contract price in the denominator. Back-adjusted prices can be zero or negative, while using current-price changes directly can create artificial volatility spikes around contract rolls.
To express price-change volatility as a percentage, the author divides it by the current contract price. A chart comparison suggests that the resulting series generally track the percentage-return estimate, with a more noticeable difference during the extreme volatility of late 2008. The text does not specify the full estimator beyond a simple rolling standard deviation example, and its evidence is visual rather than a broad quantitative evaluation. The choice of price series and denominator matters, particularly around futures rolls and when adjusted prices have unusual values.
Key ideas
- Percentage volatility can be estimated from price changes scaled by a price denominator, or from absolute price differences.
- For futures, use back-adjusted price changes with the current contract price as the denominator for percentage returns.
- Using changes in current futures prices can produce artificial volatility increases at contract rolls.
- Scaling price-change volatility by the current price makes it comparable to percentage volatility, though the estimates can differ.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.