Implied Volatility Definition. Implied Volatility is a method of measuring volatility of an underlying asset price, or relative value for a currency pair, by considering the premiums currently trading in the market and calculating the figure based on the level of the option premium. There are basically two ways to consider volatility. The first way is to calculate the standard deviation in a series of rate changes that have already occurred in the past. In this case a Trader can choose the time period that interests him, whether 10, 20 or 30 days. This calculation yields the historical volatility. However, a Trader is more concerned about future expectations and will generally seek insights from the premiums charged in the options market. This approach is called the implied volatility. Implied volatility of options rarely correlates directly to the historical values due to market uncertainty about the future. As for currency markets, most studies have found that implied volatility is a good forecaster of future volatility, much better than historical volatility, particularly over a 30-day period, as well as a period of three months. Volatility is usually stated on an annual basis as a percent of change. To adjust for a shorter time period, the annual figure must be divided by the square root of the number of periods in one year.
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