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Using Realized Volatility Cones to Assess Implied Volatility

Article Quant Q&A · Author: d_e
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Summary

The document asks how current and historical volatility, including skew, relate to observed option implied volatility. It frames implied volatility as potentially reflecting both the underlying asset’s volatility history and current conditions, as well as forward-looking market expectations such as an upcoming significant release. The aim is to estimate how much the observed implied volatility can be anticipated from volatility measures already available.

The answer offers volatility cones based on realized volatility as a simple approach for implied volatility analysis. Such cones summarize the range of realized volatility across horizons and can provide historical context for comparing current option volatility. However, the response gives no calculation details, empirical results, or direct method for modeling skew or isolating event expectations. The suggestion is therefore a starting point for assessing volatility levels, not evidence that realized volatility alone predicts implied volatility reliably.

Key ideas

  • The question separates historical and current volatility information from forward-looking market expectations embedded in options.
  • Realized volatility cones are suggested as a simple way to contextualize implied volatility.
  • The response does not provide evidence on predictive accuracy or describe a model for skew.
  • Historical volatility comparisons alone may not capture expectations of upcoming events.

Tags

OptionsVolatilityStatistics
Full text
# Predicting Implied Volatility from current and historical volatility


# Predicting Implied Volatility from current and historical volatility












Options implied volatility (IV) and skew can be calculated using the current option prices. I ask to what extent those observed variables are expected to deviate from the "expected" or predicted values for those parameters.

Specifically, it is reasonable to assume that the current IV is a function of the current and historical volatility pattern of the underlying asset plus an extra variable representative of the genuine forward-looking expectation of the market participants (i.e., in case a significant release is pending).

My goal is to assess the weight of the "current and historical volatility and skew" in predicting the current IV and skew. In other words: how good is this at predicting the current IV.

## Answer by pyCthon (score 4)

https://quant.stackexchange.com/a/75113

One simple approach for IV is to use volatility cones based off of realized volatility. See this PDF for an explanation of the approach https://www.m-x.ca/f_publications_en/cone_vol_en.pdf and this blog with some python code and an example https://quantpy.com.au/black-scholes-model/historical-volatility-cones/

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.