The volatility of an underlying price/ rate (in a derivative) that is predicted today as associated with a future date. In calculation, it is the forward variance of the price/ rate. It can be perceived as the expected spot volatility (forward spot volatility) at a certain future date. Forward volatility captures the magnitude of a price or rate’s movement going forward over a period of time. Forward volatility is amongst the five factors used in option pricing models (e.g., Black-Scholes model) in addition to underlying price, strike price, cost of carry, and time to expiration.
In practice, forward volatility can only be predicted or expected with a degree of error. If it were known after all, there would be no room for trading.
Comments