Managing Volatility

In a cooperation with Business Insider Magazine “Learning from the super-rich”, BeeWyzer is contributing articles and webinars since January 2025 in order to contribute lessons from managing big wealth to a broader public. In the end, an increase in wealth and investable assets is a driver of economic growth and beneficial for everybody. We are happy to share the articles in our blog also – feel free to skip if you are an expert already and enjoy the read if they offer valuable knowledge to you!

Volatility as an asset class: How you as investor can use it for trades, hedging and additional income - risk and opportunity

By Christian Stadermann and Peter Brock, BeeWyzer GmbH

Volatility is often mentioned in reports on financial markets, and the word itself makes it clear that we are talking about the fluctuation of prices and quotess. But very few private investors have studied the term in depth – maybe they should. That's why we want to take a closer look at it today from a mathematical, philosophical and tactical perspective.

In financial mathematics, volatility is the squared standard deviation. It therefore corresponds to variance known from statistics and always assumes a positive value. There are many example calculations and videos online that explain this clearly, so we will not go into it here. Just this much:

- With historical volatility, the figures from the past - often 250 trading days representing approximately one year - are used. This means that on each trading day, one figure is added and another on figure is removed. Extreme events can therefore distort the picture - in any direction.

- In the case of implied volatility, a figure is derived from current financial market instruments, such as options or forwards - in order to reflect the actual situation of future expectations.

Philosophically, 'vol' is the perfect image for the semantic identity of the word for opportunity and risk in the Chinese language: after all, it contains both and you will never get one without the other. It is therefore logical, even beyond mathematics, that the value always results in a positive number. However, philosophy also leads straight back to  investing:

When you buy stocks, you bring three potential sources of value into the portfolio: Price, dividend and vol. The price performance can be positive, zero or negative over any period of time. The dividend is positive or zero, but never negative. Vola, on the other hand, is always positive. Most private investors automatically receive value from the share price and the dividend by buying and holding the stock, but they only passively endure volatility without monetizing it. Sophisticated investors often do things differently, which is why we want to outline a few possible actions in the third section.

Tactically, volatility premiums can be earned by working with derivatives. And this does not have to be risky gambling:

- With a short put strategy, you sell a put option that gives the buyer the right to sell you a share at a certain price until the maturity of the option. If this relates to a share that you have your eye on anyway, but want to buy at a lower price, you are effectively placing a kind of ‘limit order’. But with two differences: The buyer does not have to exercise the option, so it is possible that the share will not be delivered, even if the price falls accordingly. And you as a seller receive money for the 'order' in the form of the option premium, which you will keep in any case.

- With covered call writing, shares held in the portfolio can be potentially sold at a price higher than the current market level and you also receive an option premium for this. This is a kind of ‘limit order’ when selling with the same different features as described above.

- If you hold a very large share position with high unrealized gains, you can partially hedge it by buying a put option. If the share falls, this will be partially offset by the increase in the option price. Otherwise, the option expires worthless at the end and you have paid a kind of insurance premium.

- These and other tactical measures can of course be used not only for the entire share position, but also for parts of it. For example, when slowly building up a portfolio or for profit-taking via a partial sale. As volatility is the most important factor in determining the level of option premiums, there are markets, securities and phases in which this is worthwhile and others in which the risk is not adequately rewarded.

Of course, such approaches are not suitable for all investors, as not everyone wants or is able to invest so much time in mastering all the technical details that are required - and the potential risk involved, when handled unprofessionally. And not everyone wants to implement such an approach with the help of an advisor.

But every investor should have an understanding of volatility, because many modern financial products work with it and the difference between market volatility and the 'vol' calculated in the product is often a source of good returns for producers, which investors pay without realizing it.

Last but not least, asset managers who use volatility premiums as an investment approach should also be mentioned here. These are also available in fund wrappers and are therefore accessible to all investors. Volatility is often referred to as an asset class, but whether this classification is correct raises another philosophical question.

In short: volatility is fluctuation in both directions as opportunity and risk. I always hold ‘vol’, when I am investing. I can passively benefit or suffer from volatility. But I can also actively deal with it - for additional returns and risk reduction.