enter image description hereThink or swim has this thing where they have do a implied volatility of a stock. I have chatted with the TOS people but they aren't terribly helpful. Regardless they did send me two images of what they consider to the be formula. I'm not exactly sure if this is a good formula or something they just made up for me to go away. So I have attached the two screen shot.

Based on my poking around I would guess it's the weekly implied averages of the options one month out?

Update: I'm starting a bounty, cause I need to see a real life example from the US stock exchange, such as CMG, NFLX or whatever.

Does anybody have a clue where this formula came from, the implied volatility of stock formula? TOS formula is below, but I'm thinking it's weekly averages one month out? Thanks

enter image description here enter image description here

Update: I'm starting a bounty, cause I need to see a real life example from the US stock exchange, such as CMG, NFLX or whatever. Although I believe the answer to be correct, I need a real life example to understand it.

  • 4
    It's not clear what kind of real life example you want. This is simply the implied volatility calculated by root solving the Black and Scholes formula. – Freelunch Jan 23 at 10:40
  • 1
    See e.g. quant.stackexchange.com/questions/15198 for an implementation of the Newton method to find the implied vol. – LocalVolatility Jan 23 at 10:45
  • I understand how to calculate Implied Volatility of an option. I have written that code in PHP. I clearly get that. However Think or Swim has a formula that calculates the IV of a stock. (see above) I want an example of how calculate the IV of a stock not an option. This is pretty rare formula and I can't seem to find an example. – Chad Jan 23 at 17:05
  • Review the Black and Scholes model, the implied volatility of an option is the implied volatility of the underlying stock. – Freelunch Jan 24 at 7:33
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    @Chad I really think you should try to read everyone's answers/comments again, because this question is thoroughly answered. The chart is simply showing the implied volatility of a stock, which is calculated based on options on the stock (mostly like based on a rolling tenor, perhaps rolling 1m or rolling 3m expiry options – you have to ask TOS what expiry they are using). The formula you quoted, as everyone has mentioned, is simply the numerical method for computing implied volatility of an option – the Black-Sholes formula has no closed form solution, this is how you solve it. – Helin Jan 27 at 8:12

What they gave you is Newton's formula.

If you have a function $f(x)$ then you can find the value $x_0$ such that $f(x_0) = 0$ by this method. It uses the derivative $f'$ which in your case is the vega.

Your function is: $$ f(x) = BS(x) - M $$ where $BS$ is the theoretical price with volatility $x$ and $M$ is the marketprice. Then $f'(x)$ is the derivative of the theoretical privce w.r.t. to the volatility - thus the vega. Note that

$$f(x_0) = 0 \Leftrightarrow BS(x_0) = M$$ for some volatility $x_0$.

The equation with the $\epsilon$ means that you stop if two consecutive values are close enough.

  • From best I can tell this looks like the answer and although I understand the BS model, my background is programming (python,php) any chance for a real life example. This looks like foreign programming language to me, that I can't decipher. – Chad Jan 11 at 22:12
  • This is mathematics.... The basis of lots of nice programming :) did you go through the Wikipedia article? Or Google the method? Try it in Excel? – Richard Jan 12 at 5:39
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    Look at $f(x) = x^2-5$ which has the root at $\sqrt{5}$. Then start at $x = 10%$ and iteratively you approach the root following the formula that they provided ... Newton's formula. – Richard Jan 12 at 8:12

Richard's answer is correct, and I do not want to detract from it. But I also see now that you are looking for the implied value of stock, not just of an option. While I cannot speak to TOS' method specifically, I can tell you that it is standard convention to display the implied volatility as a weighted average of out of the money puts and calls going forward on both the first and second expiration months.

For example, the CBOE calculates the VIX as a weighted strip of options on the S&P500 Index. I.e., just like you can't actually trade an index, you cannot trade IV directly, but rather have to take a position in a tracking instrument.

A detailed description of the VIX' calculation is available on the CBOE website.

Also, see the previous post for a detailed explanation on the evolution of the VIX... I would be willing to bet that TOS mimics simpler legacy methods.

It used to be that before 2014, the VIX was calculated as follows:


Also, I am copying code from VBA which uses the Newton's algorithm to find the implied volatility of a call option given the underlying price, exercise price, time, interest, target (usually market) price of a call, and dividend yield.

  1. $d_1$
Function dOne(UnderlyingPrice, ExercisePrice, Time, Interest, Volatility, Dividend)
dOne = (Log(UnderlyingPrice / ExercisePrice) + (Interest - Dividend + 0.5 * Volatility ^ 2) * Time) / (Volatility * (Sqr(Time)))
End Function
  1. Value of call options
Function CallOption(UnderlyingPrice, ExercisePrice, Time, Interest, Volatility, Dividend)
CallOption = Exp(-Dividend * Time) * UnderlyingPrice * Application.NormSDist(dOne(UnderlyingPrice, ExercisePrice, Time, Interest, Volatility, Dividend)) - ExercisePrice * Exp(-Interest * Time) * Application.NormSDist(dOne(UnderlyingPrice, ExercisePrice, Time, Interest, Volatility, Dividend) - Volatility * Sqr(Time))
End Function 
  1. Implied call volatility
Function ImpliedCallVolatility(UnderlyingPrice, ExercisePrice, Time, Interest, Target, Dividend)
High = 5
Low = 0
Do While (High - Low) > 0.0001
If CallOption(UnderlyingPrice, ExercisePrice, Time, Interest, (High + Low) / 2, Dividend) > Target Then
High = (High + Low) / 2
Else: Low = (High + Low) / 2
End If
Loop
ImpliedCallVolatility = (High + Low) / 2
End Function

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