I know that each individual option has it's own implied volatility, but how do you go about calculating the overall implied volatility for an underlying?
For example when someone sais the IV of a certain underlying is 40%, they are not referring to a specific option/strike. They mean that the option market as a whole is implying a volatility of 40%. How is that 40% calculated? Im guessing it is something along the lines of calculating the IV for every option available and taking some sort of average?
Secondly, how do you go about calculating the historical IV over a given time period. For example in most options trading platforms (eg: TWS, ThinkOrSwim, etc) you can pull up a chart of a specific underlying along with it's IV over a given time period. How would you go about recreating that?
Again I presume you do something like:
- One day at a time, get the closing price for every active option
- Calculate the IV for all the options at every strike
- Perform some sort of average
- Move to the next day
It seems impractical to calculate the IV of every single active option. Is it perhaps only done using the front month? (and if so, does that include weeklies and monthlies?)