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Speaking of volatility. One thing you can keenly observe is to assume
that each volatility represents an individual price distribution for the
underlying. What one might expect is some kind of consensus volatility
curve which would approach normality. For years it did..until guess
when? Oct 1987. Since 1987 we have..almost always..been in a period of
fat tails..the math guys call this curtosis or psoriasis or something.
This has been the prooblem/challange with option pricing for over the
last decade. If you don't have a near normal distribution the model has
some real shortcomings and one could argue in that envirornment options
might be viewed as cheap(In my opinion they have been for about the last
decade and generally continue to be). Options are cheap..in hindsight
if actual vol exceeds implied vol. The old definition was/is option are
cheap if implied was lless than historical....well that definition has
killed more traders than.....
If we live in a period of fat tails...and again I believe we do...then
one has to be particularly careful about whatb stratagies they employ
for short term trading(again the classic example here is what happened
to Niedhoffer...by the way Natwest made $50 Million in the SPX on both
Monday and Tuesday of crash week in the house account...somebody other
than the floors was selling the 60 vols.
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