Historical Volatility: What we know so far
Analysis of historical volatility or statistical volatility shows that in rising prices, volatility tends to be lower as risk or fear subsides. When prices are declining, volatility will tend to increase.
The graph below highlights the relationship between FBMKLCI and its historical volatility (annualised, 30day), 10 day moving average volatility and 50 day moving average volatility.
As shown above (e.g period : Jan-Feb 2015, Sep-Oct 2015, Feb-Mar 2016), when FBMKLCI declines, the historical volatility increases.Even in the recent selloff in May 2016, we saw a spike in the statistical volatility.
It is important to note that as the 10-day moving average volatility moves above the 50-day moving average, the market conditions are turning bearish. And as the 10-day moving average moves below the 50-day moving average, the market conditions are expected to turn bullish. When the 10-day moving average diverges far apart from the 50-day moving average, the FBMKLCI will experience correction. Currently (in May 2016), we saw the 10D moving average volatility crosses above the 50D moving average volatility, signaling a bearish market condition.
Implied Volatility: What may happen next
Implied volatility is the market expectation of the future volatility. This can be imputed from the traded options. The following table shows the structured call warrants (with the underlying: FBMKLCI) that are currently traded on Bursa and will be expiring from August 2016 onwards:
It is observed that the average implied volatility from these structured call warrants is 15.8% which is relatively higher than the current historical volatility of 9.3%(as of 27 May 2016). Market expects more volatility in the next few months. Unfortunately, volatility does not predict the direction of the underlying. Based on the implied volatility of the structured warrants, there is 68% chance (i.e based on 1-standard deviation) that FBMKLCI may trade between 1,335.5 and 1,938.9 up to 31 Jan 2017.
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