Sunday, March 10th 2019
Options Secrets: The Important Signals from Forward Implied Volatilities
Forward implied volatilities are important indicators of market sentiment and future performance of the stock and historical volatility.
The ratio of flat forwards to regular forwards is an important indicator of future stock movement. Extremes in this ratio have led to extremes in underlying stock movement. The signal currently suggests a potential downturn in the market. Access to the ORATS forward ratio is available through their Data API free trial.
We discussed the calculations of forward volatilities and flat forward volatilities in this prior post.
Today we will talk about a little know secret derived from the relationships of flat forward and forward volatilities calculations. And the bulls may not like what the signal is saying now.
Flat forwards are much less used than the normal forward volatility computation. Expert calendar spread traders use this calculation to exploit anomalies in the term structure. Flat forwards are more important to these traders because the calculation shows the IV level where both the front month and the back month match.
The ratio of flat forwards to regular forwards are important indicators in future stock movement. In our studies, extremes in the ratio of the flat forward and regular forward led to extremes in the underlying stock movement.
Let's look at two very different scenarios, the quiet 2017 and the volatile February 2018.
The quietest month of 2017 was October (ironically) with a historical volatility of 5.4%. Oct 2017 was also the high of the forward ratio.
The volatile February 2018 was preceded by a drop in the forward ratio. And so was the volatile October 2018 and December 2018.
What the signal now? Not good. And this may not bode well for the market.
Get access to the ORATS forward ratio today and get in on this options secret!
Options pricing models produce theoretical values for options and implied volatilities. Here we show common methods for calculating IV and how to interpret them.
Implied volatility, contango, and forward volatility can be used to predict underlying movement. Ex-earnings IV for stocks is explained. Backwardation is described as is the flat volatility method.