Volatility is mean reverting. This is one of the laws of options trading that holds the whole options universe together.
If Volatility does not mean revert, then it’s possible that many of the players in the business would not be able to do their jobs.
This does not mean it can’t change over time, the nature of stocks CHANGE. Companies morph from one idea to another. One classic example I like to point out is Corning.
For something like 50 years Corning was famous for making one thing: Corning Ware.
You know the white baking dish with the blue decoration on the side:
Yet from the 90’s on, the concept of what Corning did changed. The company actually sold off its name sake and became the maker of materials for high technology and science.
The time you most likely use a Corning product NOW is when you are using your cell phone, because Corning makes the glass for many phones.
Obviously, when the company changed its entire business its volatility HAD to change. With Corning the added volatility of a change in business worked in the investors’ favor. In the case of Worldcom… that was NOT the result.
But does a company have to change in its entirety to see a material change in its ‘mean volatility.’ The answer is no. There are some docile reasons that I will get to another time. In this case I want you to take a look at THIS chart of realized volatility in General Electric going back 8 years:
I think you should be able to see that there is a material change in volatility in GE. Why? Did the company change its whole business model?
No, last I checked they are still a huge multinational conglomerate.
What happened is the company got WAY worse at executing its business. Thus, trading GE now is NOTHING like trading it in 2013. There is a completely different set of risks.
Thus, its long term mean has completely changed, not because it is a different company like Corning, but because the risks to the same company have changed.
Why is this important, because as you trade it is important to examine not just WHAT the current volatility landscape is, relative to its mean…
But whether the current volatility landscape could BECOME the mean.
The S&P 500 may be reliable when it comes to mean reversion (more on that as well at a later date) but stocks for certain DO NOT.
Your Only Option,
P.S. We have mentoring services. Email or me or respond to this email to inquire.