A ratio that relates the implied volatility of a security to its recent historical volatility:
Volatility ratio = implied volatility / historical volatility
It presents a projection as to whether the security at hand would be less or more volatile at the present as compared to the past. The implied volatility component is derived using the Black-Scholes model, plugging in certain variables which are interest rate, time to expiration, strike price, stock price, and dividends. The volatility figure that generates the current option price is the option’s implied volatility. The option’s historical volatility (statistical volatility) measures how the option’s price changed over a course of the last 20 or 90 days.
If the implied volatility is greater (less) than the historical volatility, the market is said to be overestimating (underestimating) price uncertainty, and the options may be overvalued (undervalued).
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