Stock price movements & implied volatility : searching for predictability

Abstract

Implied volatility, as derived by reversing the Black-Scholes formula, is in theory a forecast of the volatility of the stock underlying a given option. Most research has focused upon how it performs as a forecast of realized volatility. Instead, however, this study seeks to determine whether or not implied volatility holds any predictive power over the actual movements in the stock price. Options on 24 securities-19 stocks, 2 market indices, and 3 commodity indices-were analyzed, over a total of9 months. It was found that there was significant correlation between the implied volatility of puts and calls when ordered by expiration date, though those volatilities held little explanatory power. Dividing the options based upon the class of underlying asset, only commodities were found to have any significant correlation between future price and implied volatilities, with sizable levels of explanatory power. This suggests that there may be some predictive abilities of implied volatility upon the commodities market.