Volatility Risk Premium

The Volatility Risk Premium tool measures the gap between implied volatility (forward-looking expectations) and realized volatility (actual historical movement) to identify market regimes and potential price reversals. By quantifying the insurance premium investors pay for protection against market crashes, this indicator provides actionable intelligence on whether the market is currently in a state of extreme fear, complacency, or active stress.

Usage

The Usage section focuses on interpreting the VRP level to understand the current market regime. The indicator classifies the market into five distinct states:

• Extreme (>10%): Historically wide gap where fear is significantly overpriced. Often precedes positive equity returns.
• High (5% to 10%): Elevated risk aversion usually seen after market corrections.
• Normal (0% to 5%): The typical market state where sellers collect a modest premium.
• Low (-2% to 0%): Signals unusual complacency or realized volatility beginning to catch up with expectations.
• Negative (< -2%): Realized volatility exceeds expectations, indicating active market stress. Deeply negative readings often coincide with market bottoms.

Users can leverage the Mean Reversion signals to identify when the VRP has reached a statistical extreme (Z-score) and is beginning to normalize.

Details

This indicator is built upon seminal academic research from Carr & Wu (2009), Bollerslev et al. (2009), and Bakshi & Kapadia (2003). It uses the CBOE Volatility Index (VIX) as the source for implied volatility and compares it against realized volatility calculated from the S&P 500.

A core concept of the indicator is the Term Structure Analysis, which compares short-term (e.g., 10-day) and long-term (e.g., 60-day) realized volatility. In healthy markets, short-term volatility is lower than long-term (contango), while inversions (backwardation) often serve as early warning signals for immediate market turmoil.

Settings

Core Settings

• Realized Vol Period: The lookback length for calculating historical volatility (default: 20).
• RV Calculation Method: Choose between Close-to-Close, Parkinson (uses High/Low), or Garman-Klass (uses OHLC) estimators.
• VRP Smoothing (EMA): Applied to the raw VRP signal to filter out noise.
• Statistical Lookback: The window used for Z-score and percentile calculations.

Thresholds

• High/Extreme/Low VRP: Adjustable percentage levels that define the transitions between market regimes.

Mean Reversion & Term Structure

• Z-Score Threshold: The number of standard deviations required to trigger overbought/oversold states.
• Short/Long-Term RV Period: Lookback lengths used specifically for analyzing the volatility term structure.

FAQ

How do I access Volatility Risk Premium?

You can get access on the LuxAlgo Library for charting platforms like TradingView, MetaTrader (MT4/MT5), and NinjaTrader for free.

What is the difference between the RV Calculation methods?

The Close-to-Close method uses only daily returns, while the Parkinson and Garman-Klass estimators incorporate intraday data (High, Low, Open) to provide a more efficient measure of true volatility.

Can I use this on any asset?

While the logic can be applied elsewhere, the default settings and internal data sources (VIX/SPY) are specifically calibrated for the US Equity market. Using it on other assets may require manual symbol overrides in the script.