CTC,
A couple of comments on volatility and a suggestion.
You point out, You will find that the implied volatility seems to vary amongst the various maturities and whether the option is in or out of the money.
First of all, my suggestion was to use the historic volatility of the issue itself to help measure risk, not implied volatility in option, though my suggestion below uses an option. Of course option volatility varies with time to expiration. It's bound to. People's current judgements as to the risk in an issue over a given period of time also vary. For example, a stock that takes a short term dump on short term problems will frequently show a high volatility pricing component in the nearby options but not in the LEAPS.
Second, volatility doesn't "psychologize" about what risk-averse investors want in theory, it expresses what they in fact do with their money in relation to that issue. Understanding volatility is, IMO, much more important for appreciating market risk than beta.
(As an aside, it is often helpful to keep a ratio of implied to historic volatility as a guide to investors' present perception of risk in an issue compared to their future expectation of volatility.)
So, if one were to use volatility in a long-term model, one might consider using at-the-money LEAP volatility, which reflects investors' long-term market risk assessment of the issue.
Best,
--Steve |
