# Realized volatility forecast vs Implied volatility

I have forecasts of realized volatility, as well as implied volatility for individual traded options of the S&P500.

I want to simulate a simple trading strategy; that is, buy signal=1 if forecasted realized volatility is greater than current implied volatility. However, the literature documents that implied volatility is usually higher than realized volatility.

Are there any better approach for this simulation?

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• What implied volatility are you talking about? – will Nov 8 at 21:29
• Implied volatility for 30 days to expiry options obtained from WRDS. I have deannualized it, but it still appears a notch higher than realized volatility – Bryan Lwy Nov 9 at 2:00
• What strike are the options? Is there skew? – will yesterday

On average the implied volatility is higher than realized volatility because you can easily imagine that dealers will ask customers to pay a premium to write them options and risk manage them

you can have a look at this paper for instance

And to finish here is a little exercise to test your thinking about realized vs implied vol and hopefully help you design properly your strategy: suppose you are long a call option which you purchased at some implied vol level $$\sigma_0$$ and which you are delta-hedging. Now imagine that i grant you that "on average" over a period of time the stock realized volatility $$\sigma_r$$ will be higher than $$\sigma_0$$. In other words i tell you that in expectation $$E[\sigma_r] > \sigma_0$$