What is Volatility?
Volatility is a measure of the dispersion (or variability) of returns for a given stock or market index. A higher volatility means greater risk. Volatility is often calculated by measuring the standard deviation of returns from that same security or market index.
Volatility is often associated with big changes in either direction. For example, when stock prices rise and fall by more than one percent over an extended period of time, it’s called a volatile market. Volatility is an important factor when pricing option contracts because it affects the price of the option contract.
Volatility & Securities
When volatility is used in relation to securities, it usually means the degree of uncertainty or risk associated with the size of changes in the value of the security. A higher volatility means a security’s value can be spread out over a wider range of values. This means that the cost of the security can vary significantly in either direction over a short time frame. A lower volatility means a security’s value does tend to be more stable.
Measuring Volatility
To measure an asset’s variation, one way to quantify its daily returns is to calculate the percent change on a daily basis. Historical volatility is based upon historical prices and represents the level of variability in the return of an asset. This number is without units and is expressed as a percent.
While variance captures the distribution of returns around the mean, stock market volatility measures the dispersion of returns within a specified time period. We can report daily volatility, weeklies, monthly, or annually. Volatility is the annualized standard deviation of returns.
