The Base Volatility Menu

The Base Volatility field enables you to specify which option strikes you want to use to calculate the base volatility. You specify the strike you want by selecting the Base Volatility field and making a selection from the following menu:

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Selection
Function
At-Money
Uses the at-the-money strikes as the volatility anchor.
At-Money+
Uses the closest in-the-money strikes as the volatility anchor.
At-Money-
Uses the closest out-of-the-money strikes as the volatility anchor.
At-Money+-
Uses the closest in-the-money and the closest out-of- the-money strikes as the volatility anchor.
Custom
Uses a volatility you specify as the anchor volatility; the skew curve moves only along the X axis with the price of the underlying instrument; the curve remains fixed along the Y axis.
Cancel
Returns you to the Volatility Skew Parameters menu.

The base volatility, or anchor volatility, is the average of all the implied volatilities of the options specified by the base volatility field and the curve definition. For example, if the skew definition uses calls and puts, two expiration chains, and the base is at-the-money, the base volatility is the average implied volatility of four options: the at-the-money put and call for both expirations.

The base volatility has significance during curve application. It is the point that moves the skew curve as the market’s implied volatility changes. When you save a volatility skew, you are saving a curve shape and an anchor (base) point definition. When you apply a volatility skew, the base volatility is calculated, and the skew curve is anchored to it. If the base is the at-the-money strike and the volatility of the at-the-money strike increases, the entire curve rises on the Y axis; similarly, as the at-the-money strike changes (which implies a change in the underlying price), the entire skew curve follows it along the X axis.

During the definition process, the difference between the calculated base volatility and the skew curve volatility at the base strike price is shown in the Shift field. The value in this field indicates how well the curve matches the base, at the moment. The smaller the Shift, the closer the match. When the curve is applied, it is anchored to the base volatility, and the Shift will be zero (0).

Selection	Function
At-Money	Uses the at-the-money strikes as the volatility anchor.
At-Money+	Uses the closest in-the-money strikes as the volatility anchor.
At-Money-	Uses the closest out-of-the-money strikes as the volatility anchor.
At-Money+-	Uses the closest in-the-money and the closest out-of- the-money strikes as the volatility anchor.
Custom	Uses a volatility you specify as the anchor volatility; the skew curve moves only along the X axis with the price of the underlying instrument; the curve remains fixed along the Y axis.
Cancel	Returns you to the Volatility Skew Parameters menu.