Implied volatility in gold trading

Implied volatility is the volatility that, when fed into an option pricing model, reproduces the current market price of the option. It is the market’s forecast of how much gold will move over the option’s life, expressed as an annualized percentage. Unlike ATR, which looks back at realized moves, implied volatility looks forward. Cboe’s Gold ETF Volatility Index (GVZ) tracks implied volatility of options on GLD and is the gold equivalent of the VIX.

How it applies to gold trading

Implied volatility rises into scheduled events, FOMC meetings, CPI and NFP, and falls immediately after, a pattern called the volatility crush. It tells a spot trader what size of move the options market considers normal: an implied volatility of 16% annualized corresponds to a one-day move of about 1%, roughly $40 at a $4,000 price, as a one-standard-deviation expectation. When the market has moved more than that in an hour, stops based on normal conditions are not appropriate.

Comparing implied with realized volatility shows whether options are pricing more or less movement than gold has been delivering, which option traders use to decide whether to buy or sell volatility.

Checking GVZ before a scheduled event gives a quick sense of how much movement the options market has priced in, which is a useful cross-check on an ATR-based stop for that day.

A common mistake

Reading a high implied volatility as a directional signal. It says the market expects a big move, not which way.

See also: Volatility, Options on gold, ATR, FOMC.

Frequently asked questions