V

VALUE-AT-RISK
The value-at-risk (VAR) of a portfolio is the worst loss expected to be suffered over a given period of time with a given probability. The time period is known as the holding period and the probability is known as the confidence interval. Value-at-risk is not an estimate of the worst possible loss, but the largest likely loss. For example, a firm might estimate its VAR over ten days to be $100 million with a confidence interval of 95%. This would mean there is a one-in-twenty (5%) chance of a loss larger than $100 million in the next 10 days.
In order to calculate VAR, a firm must model both the way the relevant market factors will change over the holding period and the way (if any) in which these changes are correlated between market factors. It must then evaluate the potential effects of these changes on its portfolio at the desired level of consolidation (by asset class, group or business line, for example).

VARIATION MARGIN
The margin adjustment which must be paid on a derivatives contract whose value varies in line with levels of volatility in the market. The higher the fluctuations in daily prices, the higher the variation margin which participants may be required to add on to their original margin.

VEGA
Option risk parameter which measures the sensitivity of the option price to changes in the price volatility of the underlying instrument.

VERTICAL SPREAD
An option strategy relying on the difference in premium between two options which share a common underlying and maturity, but are struck at different prices.
See put spread, call spread

VISCOSITY
A measurement of a liquid’s resistance to flow. As temperature increases, viscosity decreases.

VOLATILITY
A measure of the variability of a market factor, most often the price of the underlying instrument. Volatility is defined mathematically as the annualized standard deviation of the natural log of the ratio of two successive prices; the actual volatility realized over a period of time (the historic or historical volatility) can be calculated from recorded data.
Volatility is one of the variables which must be specified in the Black-Scholes model of option pricing: a vanilla or non-exotic option will cost more when volatility is high than when it is low. However, volatility is the only one of these variables whose value must be estimated. The estimate used (known as the implied volatility) can be derived from the prices of options in the market and the known input variables. However, the Black-Scholes model also assumes that volatility is constant, which is not true. New techniques have been developed to cope with volatility’s variability, including mean-reverting models (such as Garch) and stochastic volatility models.

VOLATILITY SKEW
The difference in implied volatility between out-of-the-money puts and calls. The origins of the volatility skew are not always clear, but factors may include reluctance to write calls rather than puts, sentiment about market direction, and supply and demand.

VOLATILITY SMILE
If the implied volatility of an option is plotted against its strike on a graph, the chart is typically shaped like a smile (less frequently a frown). This curve is known as the volatility smile. It may reflect the fact that out-of-the-money events are more common than geometric Brownian motion would predict. This leads to extra value for out-of-the-money options.

VOLATILITY TERM STRUCTURE
The term structure of volatility is the curve depicting the differing implied volatilities of options with differing maturities. The term structure is curved because the volatility implied by short-dated option prices changes faster than that implied by longer-term options, but other effects, such as mean reversion, may also play a part.

VOLATILITY TRADING
Trading, usually through the options markets, based on the belief that implied volatility will not match the volatility actually realized over a given period, or that the difference in implied volatility between different options will alter over a given period. Options are used because of their sensitivity to volatility.