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Understanding Volatility Cones

Volatility cones can be a powerful tool for options analysis but many traders don’t know how to use them. They normalize ATM (at-the-money) volatility curves based on the number of days to expiration. This gives you the ability to quickly and accurately assess a contract’s volatility level related to where recent contracts have traded given the same remaining number of trading days.

To access QuikStrike’s vol cone tool, first navigate to QuikVol in the upper left hand corner of QuikStrike. Under QuikVol Home, go to Volatility Cones:

 

 

From here, select the product you’d like to view as usual. We’ve selected Interest Rates –> US Rates –> Eurodollars. If you haven’t used vol cones with the selected product before, QuikStrike will prompt you to select the expirations you’d like to view. To do this, go to the Expirations dropdown menu above the charting area.

 

Once you’ve selected your expirations you should get something like this:

The y-axis shows the volatility and the x-axis shows the number of days until contract expiration.

Note that Essentials users will default to vol cones generated from one month of history while paid users will default to six months of history. Both versions allow you to show curves from historical dates under the “Compare” drop down menu, and both versions give you display options (for example, some users prefer to reverse the orientation of the x-axis to show 0 Days to Expiration on the right hand side).

Decoding the Cones

The lightest color cone (grey shaded area), labeled “Min/Max”, contains all of the vol levels for the time period specified in the “Date Range” drop down menu. The next lightest cone, labeled “5/95” contains 90% of the vol range (excluding 5% on the downside and 5% on the upside). The third cone, labeled “LQ/UQ” – for lower quartile and upper quartile – contains 50% of the historical vol range (excluding 25% on the downside and 25% on the upside).

The arithmetic mean is shown in dark grey and the interpolated curve based on the most recent measurements is shown in black. Markers denote contracts (diamonds) and constant maturity values (circles). Clicking on a marker will bring up its details:

In this example, the Jan18 contract (EDF18) is trading below the average vol level for a contract with 45 days to expiry but is within the LQ/UQ cone. Feb18 and Mar18 (visible in the full vol cone screenshot) are both well below average, but the Apr18 (EDJ18), Jun18 (EDM18), and Sep (EDU18) contracts all have vol levels above the six-month mean.