What Is a Change?
In general, a change refers to a price difference that occurs between two points in time. This can refer to several specific price changes in finance, each of which is calculated in a somewhat specific manner:
- For an options or futures contract, it is the difference between the current price and the previous day's settlement price. For an index or average, change is the difference between the current value and the previous day's market close.
- For a stock or bond quote, change is the difference between the current price and the last trade of the previous day.
- For interest rates, change is benchmarked against a major market rate (e.g., LIBOR) and may only be updated as infrequently as once a quarter.
- A change is the difference in price observed in a security, asset, or other object over time.
- Depending on the particular type of asset or security, a change in value is calculated in a different manner.
- The more rapidly change occurs, the more volatile a price is said to be.
Change is a commonly used term in the world of finance, though it has many names. Another word for change is volatility. The change in earnings is described as earnings growth. The change in revenue is referred to as revenue growth. The change in earnings divided by an investment such as assets or equity is referred to as return on investment or return on assets.
In essence, change is the foundation for measuring and describing data over a certain period of time. A positive change generally implies improved performance, while a negative change implies declining performance. The interpretation of the change is left to the analyst.
In general, the formula for determining change is subtracting the previous time period from the most recent time period. For example, if a company is trading at $10 at the end of the first quarter and $20 at the end of the second quarter, the change in price over the time period is $20 minus $10, or $10.
It is important when describing this change to give it context. In this case, the change is positive, but by how much? To compare change, analysts divide the change in price by the price in the previous time period. In this example, the calculation is $10 divided by $10. The price went up from $10 to $20, so it doubled. Likewise, $10 divided by $10 is 100%. Another way to report this change is to say the company's stock price grew 100% in the first quarter.
The Value of Change
From an investment perspective, investors, and particularly traders of options, like change. Change is what allows investors to make a profit. In highly volatile markets, investors have many opportunities to make up for losses.
Option prices are based fundamentally on the scale of the change in the price of the underlying asset. In other words, an option contract's value is based on changing prices. For instance, one type of option, referred to as a call, is effectively a bet that the price of the underlying asset will go up. Other options, referred to as puts, bet the price of the underlying asset will go down. The more volatility there is in the market, the more likely that either event will occur, and that the option holders will make a profit. As a result, option prices increase with implied volatility (IV).