How to calculate volatility based on the expected return of a straddle strategy has been shown in part 1 of fair bet volatility KVOL.
Using and Displaying Volatility:
KVOL uses the given amount of historic returns to calculate an expected value of an at the money put and call option. The sum of these prices are the historic fair value for implied volatility. It can be used to compare current market implied volatility to historic fair values.
Beside calculating KVOL for a specific return period it can also be used to show it as a projection indicator on the chart.
The example on the chart gives such an expectation channel for the s&P500 at the beginning of each month. The 250 days before are used to calculate KVOL. The line underneath the chart is running KVOL for 13 trading days.
to win, with higher volatility expected: you would have bought a straddle at the beginning of the month, expiring at the end of the month. You should not have paid more than a KVOL for 25 bars (working days to expiry) would have suggested. You win if the chart is outside of the projection at the end of the month.
The shown example uses the 250 daily bars before the beginning of the month to calculate the returns and the price of KVOL. The projected lines represent the winning boundaries of the straddle at expiry.
Comparing this to actual prices for a straddle you will notice…
… that current KVOL around 50 is higher than the given straddle price of 44.90. This might suggest that a long straddle is a better deal than a short straddle would be…