Saturday, 12 September 2015

Warrants: Historical Volatility

Historical volatility reflects the historical price of a stock within a given period of time.

If Stock A is trading at $10 with a volatility of 10%, then based on the theories of statistics, there is

-  68% of the time that the stock will be trading within the range of $9 to $11 ($10 +/- 1 S.D.),
-  95% of the time within the range of $8 to $12  ($10 +/- 2 S.D.)and
-  99.7% of the time within the range of $7 to $13  ($10 +/- 3 S.D.).

In other words, the higher the historical volatility of the underlying, the higher the level of its future volatility will be in a given period of time.

For the investors
Investors can use historical volatility to predict the future volatility and price direction in order to formulate their investment strategies.

For the issuer
For the issuer, historical volatility is one of the factors they need to take into account in determining the price of a warrant.
Where the historical volatility of its underlying is high, a warrant is likely to be issued at a higher price. However, past performance may not indicate future trends.
Hence, in the pricing process, an issuer will alos find out what the markte expects of the future volatility of the underlying, that is what we call the "implied volatility" of the warrant.

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