Volatility refers to the fluctuations in the price of a security, commodity, currency, or index.
One general way to measure volatility is to look at the Beta coefficient. This measures the historical movement of a financial instrument against a suitable baseline (a FTSE 100 stock against the FTSE 100, for example). The index is considered to have a beta of one. A stock with a beta of one would be expected to move roughly in line with the market. A share with a beta greater than one would be considered, in most cases, to be more volatile than the market as a whole. One with a beta of two, for instance, would be expected to rise 20% for every 10% that the wider market moved – assuming that historical trends held good.
Options trading strategies depend on the volatility of the asset on which they are based. The larger and more frequent the moves in an asset price, the more valuable the option is deemed to be. This is because there is a greater likelihood that the option will have some value at the end of its life. Increased volatility also means that during the life of the option there is more scope for arbitrage and for making profits from hedging strategies.