Daily Volatility Summary

Pricing Models
The Daily Volatility Summary processes end-of-day data using standard option pricing models. Contracts that permit early exercise (American-style) are analyzed using the quadratic approximation method. Contracts that must be held until expiration are priced using the Black-Scholes model.

The pricing inputs for the models are price of the underlying instrument, days until expiration, strike price, interest rate, and annualized volatility of the underlying.

The values for all the inputs except volatility are easily obtained. To arrive at a volatility there are two methods employed: implying volatilities from the price of an option and tracking the actual historical volatility from the underlying.

Implying Volatilities
Usually the five pricing inputs produce an option price. If you already know the price of an option, you can imply what the volatility is. A higher volatility results in more a more expensive option price. The ATM (at-the-money) volatility is interpolated from the volatilities of the two strikes that are nearest to the current price of the underlying instrument.

Historical Volatilities
The historical volatility of the underlying futures is given for a variety of time periods. All volatilities are annualized.

Standard Deviations
The implied volatilities of ATM option settlements are used to calculate futures ranges representing one standard deviation. These futures ranges provide a way to measure and think about time and volatility that is more concrete and understandable. These statistically expected futures ranges, in various time periods, are expressed in futures points. As an example, if the 1-wk standard deviation is 1.52 and the current futures price is 55.00, then statistically there is a 68.3% chance that within a seven day time period, the futures will range between 53.48 and 56.52. Two times the standard deviation (3.04 futures points) represents a 95.4% statistical chance, and three times (5.56 futures points) 99.7%.

Throughout, ATM means at-the-money. Thus, the ATM strike is the strike nearest the current futures price. OTM refers to the option that is out-of-the-money. If the current futures price is 63.05 and the 58 strike is being analyzed, then the 58 put is the out-of-the-money (OTM) option. Because the 58 call has intrinsic value, it is the in-the-money (ITM) option. For each strike, a volatility is implied from the settlement price of the out-of-the-money option. In the case where the futures settle exactly at the strike, the call and put volatilities are averaged. In addition to showing the implied volatility of each strike, the Daily Summary calculates an at-the-money volatility for each contract month. If the DMark futures settle in between strikes, the "ATM volatility" is interpolated between the two strikes nearest the futures price. For example, if the futures settle at a price of 72.20, and if the 72 strike settles at 11 percent volatility, and the 73 strike settles at 12 percent, then the ATM volatility would be 11.2 percent. Please note that prices of cabinet are not printed. It is to be assumed that the only price lower than a single tick is CAB. Also, all option prices are printed without decimals or dashes separating the points from the ticks.

The delta indicates how much the option price is expected to change relative to change in the underlying. If an option's delta is .50, the option price is expected increase 1 tick for every 2 tick increase in the underlying futures price. Some traders use the at-the-money volatility to price options at all strikes. The Daily Summary instead uses the implied volatility to generate option deltas. That is what is meant by "Implied Delta" -- an option's delta is based on the implied volatility of that strike. Implied deltas with a "*" indicate that the call delta is calculated using the put's implied volatility or that the put delta is calculated using the call's implied volatility. It occurs when there is no option settlement price available to imply a volatility.

Ticks Over Fair
"Ticks Over" refers to difference between the option's current price and the price of the option if the ATM volatility were used to generate an option price. It represents the amount of skew (in ticks) that is in an option's price.

CR: Conversion/Reversal
CR describes the amount of money (in ticks) that traders demand to carry the in-the-money option to expiration. As an example, imagine that the March DMark futures are at 58.50, the 60 put is at 2.41 and the 60 call at .94

Since the put is 1.50 in-the-money, .91 is pure premium (extrinsic value).

If the out-of-the-money option has 94 ticks of extrinsic value and the in-the-money has 91 ticks of extrinsic value, then the CR value is 3.
CR is always expressed as an absolute value.

Skew The skew curve is a graph of volatilities across strikes. In theory, all strikes should trade at the same volatility since they are all based on the same underlying instrument. Instead, in the real market, each strike trades at a different volatility. If you plot these volatilities across strikes you can readily determine which strikes the market demands. The skew curve results from supply and demand. Whichever strikes are in demand will trade at a higher volatility (price).

A curve that slopes upward indicates that traders are selling downside options and buying upside options. This indicates that the market is worried about a huge upside swing. In the case of markets like the S&P options, the hedge market worries about moves to the downside. Therefore, hedgers buy downside puts and sell upside calls. Buying downside puts is like buying insurance. Selling the upside calls is a way to earn back some of the money that it costs to buy the downside protection. Some markets, many of them currencies, have no directional bias. In these cases, there is both a positive upside call skew and a positive downside put skew. The shape of the curve is like a smile which is why some traders refer to the skew as the "volatility smile".

Another benefit of the skew is that it generally indicates what will happen to the at-the-money volatility when the futures swing one way or the other. If a skew is positive to the upside, that generally indicates that the at-the-money volatility will be higher when the underlying makes a significant upside move.


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