Measures of volatility
In this lesson, you'll learn how to calculate and convert volatility measures for use in the Black-Scholes option pricing model. The Black-Scholes model requires an annual standard deviation rate, but exam questions often provide variance or non-annual figures like weekly or monthly data.
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In this lesson
- 0:00 Measures of volatility in option pricing
- 0:39 Converting standard deviation to annual rates
- 1:42 Worked example: weekly to annual conversion
About this lesson
You'll master the conversion process so you can handle any volatility input confidently. The core technique involves three straightforward steps. First, if given variance, simply take the square root to find standard deviation. If given a non-annual standard deviation (weekly, monthly, etc.), square it to convert to variance, then multiply by the appropriate factor to annualise it—52 for weekly data, 12 for monthly. Finally, take the square root of your result to get the annual standard deviation you need for the model. This skill is essential for Advanced Financial Management (AFM) and Strategic Business Leader (SBL) papers where option pricing and valuation appear. The lesson walks through a worked example showing how to convert a weekly standard deviation of 2% into an annual figure of 14.42%, demonstrating exactly how to apply these steps under exam conditions. Master this conversion and you'll handle volatility inputs with confidence, no matter how they're presented in the question.
Duration: 3m
Transcript
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