Estimating Next-Day Implied Volatility from Option Expiries
Summary
The document considers whether options can reveal volatility over a specific upcoming interval, such as a trading day containing a scheduled central-bank announcement. It notes that implied volatility is only directly observable for horizons with liquid options, so market quotes may not isolate overnight movement, an event window, and subsequent trading separately.
One suggested approximation compares total implied variance across expiries to infer variance attributable to the additional interval. The source describes this as a rough clue and includes overnight and event risk within the inferred segment; its written subtraction is ambiguous and should not be treated as a precise formula. As an alternative, it proposes fitting a volatility-surface model such as SABR and interpolating across maturities. That approach also has limits: interpolation cannot reliably identify a discrete event premium unless the model or inputs represent it. No empirical demonstration is supplied.
Key ideas
- Implied volatility is directly observed only at expiries with sufficiently liquid options.
- Comparing total variance across expiries may offer a rough estimate for the added horizon.
- The inferred interval can combine overnight returns and scheduled event risk.
- A fitted volatility-surface model can interpolate maturities but may not capture an event premium.
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# How to calculate implied vol for next trading day? # How to calculate implied vol for next trading day? We can seem to get implied vol for a period from now to option expiration, but does anything tell us implied vol for the next trading day ? Like if fomc is tomorrow the next day implied vol would be much higher. ## Answer by phubaba (score 1) https://quant.stackexchange.com/a/9427 I'm going to start an answer on this and see if it generates discussion: Firstly you can't get the implied vol to a specific period unless there are options that are liquid and traded around the period you are interested in. you have four periods of vol, but you don't have listed options between the time periods (usually). from now until the close of market, from close of market until open of market, from open of market to fomc inclusive, from fomc to next day close. you might have information about the implied vol from now until close of market today (say there is an expiration on that day) and implied vol from now until close of market tomorrow. then totalVol = integral(sigma_instantenous(t)^2*dt, 0, T)/T. We can substitute sigma_instantenous(t) = implied vol, then totalVol = impv^2/T. See https://en.wikipedia.org/wiki/Realized_variance totalSigma(now until eod tomorrow) = impv(now to eod tomorrow)^2*t(now to eod tomorrow) totalSigma(now until eod today) = impv(now to eod tomorrow)^2*t(now to eod tomorrow) totalSigma from eod today to eodTomorrow = impv(now until eod tomorrow)-impv(now until eod today) note this period includes both the overnight return and the fomc event. This might give you an idea. An alternative method is to take the model approach. Fit a model such as sabr to the implied volatility surface, you can interpolate to different time periods. Granted this will likely not nicely take into consideration your fomc event:) See for example http://www.maths.ox.ac.uk/system/files/private/active/0/On%20expansions%20for%20the%20SABR%20model.pdf
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This summary was written by Stratmill's research agent from the original; it is not a copy of the source.