While implied volatility gets most of the attention, historical volatility is equally important for options traders. Understanding HV helps you determine whether options are overpriced or underpriced, and it gives you insight into how a stock actually moves. This guide will teach you everything you need to know about historical volatility.
What is Historical Volatility?
Historical volatility (HV), also called realized volatility or statistical volatility, measures how much a stock's price has actually moved in the past. It is calculated using past price data and expressed as an annualized percentage.
Key difference: Implied volatility tells you what the market expects will happen. Historical volatility tells you what actually happened. Comparing the two reveals whether options are cheap or expensive.
How Historical Volatility is Calculated
HV is calculated using the standard deviation of daily returns over a specific period, then annualized. The most common lookback periods are 10, 20, 30, and 60 days.
Simple HV Calculation Steps
- Calculate daily returns: (Today's close - Yesterday's close) / Yesterday's close
- Find the standard deviation of these returns over your lookback period
- Annualize by multiplying by the square root of 252 (trading days per year)
A stock with 20-day HV of 25% has moved at a rate that would translate to 25% annual movement if that pace continued.
Common HV Lookback Periods
Different lookback periods tell different stories about volatility:
- 10-day HV: Short-term volatility, reacts quickly to recent moves
- 20-day HV: Popular for comparing to monthly options
- 30-day HV: Standard benchmark, good for general analysis
- 60-day HV: Smoother, shows intermediate-term volatility trends
- 252-day HV: Full year view, useful for long-term comparisons
Comparing HV to IV: The Key Trading Edge
The relationship between historical volatility and implied volatility is one of the most important concepts in options trading. When IV is higher than HV, options may be overpriced. When IV is lower than HV, options may be underpriced.
HV vs IV Analysis Example
Stock ABC shows the following:
- Current IV: 45%
- 30-day HV: 28%
- Difference: IV is 17 points higher than HV
This suggests options are expensive. The market is pricing in more volatility than the stock has historically delivered. This could be a good opportunity to sell options.
Trading Strategies Based on HV vs IV
When IV is Much Higher Than HV
Options are likely overpriced. Consider selling strategies:
- Credit spreads (put or call)
- Iron condors
- Short strangles or straddles
- Covered calls
When IV is Much Lower Than HV
Options are likely underpriced. Consider buying strategies:
- Long straddles or strangles
- Debit spreads
- Calendar spreads (buy the back month)
- Long calls or puts for directional trades
Using HV to Set Price Targets
Historical volatility can help you set realistic price targets and strike prices for your trades. The expected move based on HV gives you a statistical framework for decision-making.
Calculating Expected Move from HV
Stock price: $100, 30-day HV: 24%
- Daily expected move: 24% / sqrt(252) = 1.5%
- Weekly expected move: 24% / sqrt(52) = 3.3%
- Monthly expected move: 24% / sqrt(12) = 6.9%
Based on historical patterns, you can expect the stock to stay within roughly $93 to $107 over the next month about 68% of the time (one standard deviation).
HV Trends and What They Signal
Watching how HV changes over time provides valuable trading signals:
- Rising HV: The stock is becoming more volatile, often during trending markets or uncertainty
- Falling HV: The stock is calming down, often during consolidation periods
- HV spike: Usually follows a big move, may indicate a turning point
- HV at lows: Often precedes a volatility expansion (be prepared for a big move)
Pro tip: When both HV and IV are at historical lows, the stock is in a compression phase. This often precedes a significant breakout in either direction. Consider long volatility strategies like straddles.
Common Mistakes When Using HV
- Using only one lookback period: Compare multiple periods (10, 20, 30-day) for a complete picture
- Ignoring recent events: HV is backward-looking and may not capture upcoming catalysts
- Not accounting for earnings: HV spikes around earnings are normal and temporary
- Comparing apples to oranges: Different stocks have different normal HV ranges
- Assuming mean reversion: While volatility tends to mean-revert, timing is difficult
Building an HV-Based Trading Approach
Here is a systematic way to incorporate HV into your trading:
- Calculate the IV/HV ratio: Values above 1.2 suggest expensive options, below 0.8 suggest cheap options
- Check HV percentile: Is current HV high or low compared to its own history?
- Look for convergence: When short-term HV (10-day) is much different from longer-term HV (30-day), expect reversion
- Combine with IV Rank: Best setups occur when both metrics align
- Trade the appropriate strategy: High IV/HV ratio = sell premium, Low IV/HV ratio = buy premium
Monitor HV Across Your Watchlist
Pro Trader Dashboard tracks historical volatility alongside implied volatility, helping you find the best volatility trading opportunities. Compare HV to IV with one glance.
Summary
Historical volatility is an essential tool for options traders. It tells you how much a stock has actually moved, allowing you to compare this to what the options market is pricing in via implied volatility. When IV is high relative to HV, consider selling options. When IV is low relative to HV, consider buying options. Use multiple HV lookback periods and watch for volatility trends to improve your trading decisions.
Ready to dive deeper? Learn about implied volatility trading or discover how to use IV Rank and IV Percentile.