The Time Dimension of Volatility: Implications for Option Strategy Design

Abstract

The volatility/time horizon connection is critical for estimating risk and for constructing downside-risk management and upside capture strategies. Differences in perceived risk depend on the return interval over which volatility is measured and should be aligned with the horizon for monitoring and rebalancing an investment strategy. A comparison of realized S&P 500 volatility measured from daily versus monthly returns over the 2000–2021 period showed that daily returns were about 30% more volatile on average than monthly returns. This time variation in volatility also impacts the selection of strike prices for option strategy design. The distribution of S&P 500 total returns for investment horizons ranging from 1 to 12 months was examined to assess the differences in the frequency of outcomes relative to threshold levels across holding periods. The net delta of an option strategy is the best guide for comparing options of different terms, enabling investors with different horizons to select option strike prices consistent with their targeted return distributions.