What is the volatility trading strategy

Implied volatility - definition & explanation

Volatility | Standard deviation

When it comes to determining risk, volatility is the most-considered metric in financial economics. Usually the volatility is calculated with the help of the statistical key figure Standard deviation measured, which typically relates to annual returns in the context of options trading.

In the literature, risk, volatility and standard deviation are often used as synonyms. Sometimes there is also talk of the so-called variance, which results from the square of the standard deviation. However, the variance is rather unsuitable for financial mathematical studies of private investors, as it is not intuitively understandable. For this reason, the standard deviation is predominantly used when calculating risk, as it is given in the same unit as the underlying return.

Risk measure

In relation to the stock market, the standard deviation is a statistical measure for the dispersion of the returns on securities over time around their arithmetic mean. Statements about the risk can only be made by determining this key figure. The standard deviation is therefore a measure of dispersion based on the so-called normal distribution. It should be noted that returns on securities are only approximately normally distributed. The longer the observation period, the less the returns deviate from a normal distribution.

So volatility corresponds to the standard deviation, which is defined as the square root of the square root of the mean square deviation of the returns on securities from their mean. In other words: The sum of the squared deviations of all returns from the arithmetic mean is divided by the number of returns and the square root is taken from this. Formulated more simply, but also more generalized, one could say that the standard deviation is the average deviation from the average.