What happens when the price volatility of a stock differs from market expectations? What type of trade strategies are used when the level of volatility is greater than historical volatility? Which strategies are used when volatility is less than historical volatility? And which strategies provide the best performance in these scenarios? Here we examine trade strategy preferences when there is a volatility surprise.

**This week’s highlights:**

- When intra-order volatility is less than the expected volatility of the trade, the preferred strategy is Hi-Touch. When intra-order volatility is higher than the expected volatility the preferred trading strategy is VWAP.
- Among the 4 types of trading strategies examined, Liquidity Seeking strategies perform best when intra-order volatility is significantly different than expected volatility.
- The worst performing strategy is VWAP when intra-order volatility is less than expected volatility. However, when the volatility surprise is the opposite – intra-order volatility is larger than expected volatility, the worst performing strategy is Hi-Touch.

We will use a metric called “Volatility Variation” to measure the extent to which volatility during the life of an order differs from historical volatility. Volatility Variation is simply:

(Intrade Volatility (from Order Arrival to Last fill) in bps / Annualized Volatility in bps) – 1

Intrade Volatility is defined for the period (Arrival-LastFill), all public trades are gathered and the total volume at each price is summed. The standard deviation of this distribution is then computed. Note that the mean (average) of the distribution is the Volume Weighted Average Price or VWAP. The width of this distribution (calculated using the standard deviation) is what is referred to as the trade-based intraday volatility. If all volume is done at same price, volatility is zero. As volume becomes spread across many prices, the volatility increases.

Read more here.

By Henry Yegerman, ISS LiquidMaterix