An implied volatility surface is a 3-D plot that maps out the smile/skew/smirk and term structure of volatility implied from option chain data. This surface is normally developed by taking option market data relating to prices, bids and offers and interpolating that data using Black Scholes. The VIX similarly is an estimate of ex ante market volatility but differs in respect to being a model free estimate of implied volatility. The SPX VIX, is an index of annualized volatility based on a notional 30-day options maturity for the S&P 500 calculated from a wide range of calls and puts. The volatility surface is estimated typically by brokers with a view to capturing similar insights regarding ex ante volatility or 'nervousness'. The more "nervous" markets become the more "pricey" options are. The smile/skew/smirk also reflects evidence that is now widely accepts that stock returns are not normallty distributed. In addition since 1987, most market participants have note that measures of volatility relative to "moneyness" exhibit skew. This has led to the emergence of what is known as the ad hoc model developed by Dumas, Fleming, and Whaley (1998). To construct an Implied Volatility Surface, please follow playlist. In the first video I demonstrate how to access option data from yahoo finance.
In video 2, I explain a bit the volatility smile and demonstrate how data from yahoo finance can be refined to produce a more reliable estimates of implied volatility. To access excel file.
In video 3, I clean the raw data a bit further and then introduce the VBA function for estimating Implied Volatility. I estimate the Implied Volatility of Apple Option chain data ranging from 56 days to 238 days
In video 4, I set out the ad hoc model developed by Dumas, Fleming and Whaley (1998). This can be used to generate the volatility surface. Ordinary Least Squares are used for estimating the ad hoc model parameters.
In the final video, I generate a 3-D volatility surface which traders could employ to intuit/interpolate the appropriate level of volatility consistent with term structure of the option and "moneyness" of the option. I take the estimated Dumas, Fleming and Whaley Deterministic Volatility Function and construct an interpolated Implied Volatility surface. The Determinist Volatility Function serves as an interpolation tool that permits a trader to infer what Implied Volatility value would be appropriate once the exercise price and maturity can be specified.