Our assumed tenets about volatility and movement of stocks are as follows:
1. Volatility does not predict the direction of stock movement;
2. When volatility increases, we expect condition to be bearish and vice versa; and
3. When 10D moving average volatility crosses above 50D moving average volatility, this signals increase in volatility and thus will result in potential bearishness for the particular stock and vice versa.
Let’s take a look at how volatility is interrelated with the share price movement of Sapurakencana Petroleum (a Malaysian-listed O&G stock, “SKPetro”):
It is observed:
- In general, when there were significant increases in SKPetro’s volatility (e.g Oct-Nov 14, Aug-Sep 15, Feb-Mar 16), there were declines in the share price of SKPetro.
- The relationship (i.e when volatility rises, price should decline) appears weak in 2012-2013.
- When SKPetro was trading sideways (e.g Oct 13- Sep 14), volatility declined
Volatility analysis is further analysed below, with the plotting of difference between 10D moving average volatility and 50D moving average volatility. As per our assumed tenets, when 10D MA breaches 50D MA (in few occasions shown in the graph below), we saw declines in the share price of SKPetro, in line with a more bearish sentiment / growing uncertainty.
From the above analysis, it is observed that we are currently seeing an increasing volatility for SKPetro (spike in volatility in May 2016), potentially signaling a ‘bearish’ outlook for SKPetro in the short term.
Implied Volatility : What The Market Expects
The following is an extract of currently traded structured warrants (with underlying “SKPetro”):
The future volatility of SKPetro is expected to trend higher, as shown in the above table whereby the structured warrants’ implied volatility are relatively higher than the underlying’s current historical volatility of 33.0%.
It is very important to re-emphasize that the increase or decrease in volatility does not predict the direction of the stock movement. Higher volatility means more opportunities for trading.
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