The market flux capacitor

“Fragility is the quality of things that are vulnerable to volatility.” - Nassim Nicholas Taleb

John, our by now well-known Head of Procurement for Fancy Gizmos, was sitting at his desk and working through all the New York Times puzzles. Since he had implemented Forge aHedge and automated his copper hedging and risk management he had freed up a lot of time cleaning data, downloading forecasts, and checking and double checking a sprawl of spreadsheets. I mean he had to use his extra time productively, didn’t he? There was just one problem; he was stuck on Connections.

He was concentrating intensely on the screen when Sally, Fancy Gizmo’s CFO, came by. “Ah John,“ she said, “looks like you’re working hard, good stuff.” John looked up. He was just about to ask Sally for a Connections hint when he realised that probably wasn’t the smartest thing to do. “Jill from investor relations was asking me for some analyst commentary on the increase in copper vols. I remembered you’re a lemming expert and I think lemmings are related to voles aren’t they?”

John artfully minimised the New York Times website, hoping Sally hadn’t noticed. “I think Jill is talking about volatilities, not rodents!” he said. “Volatility is a measure of how much financial market prices fluctuate over time. When volatility is high then prices can move up and down sharply, but when it’s low then price changes are much more muted. You get two main types. One is backward looking, called historical volatility. This measures how prices have changed in the past. It’s usually calculated as the standard deviation of the log of financial price returns and annualised. The second type of volatility is called implied volatility. Implied volatility is forward looking and is a forecast of what the market expects price swings to be. It is usually calculated from current option prices. It’s important to note that volatilities indicate magnitude and speed of market moves but not direction.”

“I know implied volatilities, or vols as they are called for short, have gone up significantly recently, so I assume the equity analysts are concerned there could be copper price spikes and that could hurt our earnings. Don’t worry, I’ll send you a report from Forge aHedge showing how our copper purchase budget price is protected by our hedge policy. The analysts will be able to easily understand that we are well covered against adverse price moves and be confident about our earnings forecasts.”

“Got it, “ said Sally, “implied vol is like a market flux capacitor. It seems you’re more of an expert on volatility than Connections though. Better luck tomorrow.”

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