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I strongly second Doc's suggestion about reading Natenberg's book. Shelly
Natenberg started as a floor trader in Chicago and gave seminars on options.
He finally took his excellent seminar notes and put them into book form.
The latest edition of his "Option Volatility & Pricing" has been
significantly improved from the former edition. Despite the many other books
that have come into the field in the last few years, this is the best.
On the subject of the "fat tails", ( or the "wings" as we call them) I am not
at all convinced that this is due to the greater ease in trading. I would
have thought that the greater trading would make things more liquid, with
more liquidity being a damper on volitility. ( Traders are less afraid to
sell options in a liquid environment) The hard to trade and more illiquid
markets will be more subject to surprize price pops and subsequent pops in
option volatility. ( a liquid equity option may pop from 35% vol all the way
to 50%, but in the less liquid orange juice market it can pop from 35% to 90%
with the wings becoming unpriceable ( in a mathematical sense). It is these
markets especially, where the wings become expensive (the fattest of tails)
as buyers want protection ( or a lottery ticket) and sellers are not
compensated enough for the risk of selling way out of the money options.
The mathematically almost impossible has a nasty habit of occuring with
alarming frequency in the real world. I think is the reason for the "fat
tails" and why "successful option trading is at least as much an art as a
science" (Natenberg p.418)................oh and occasionally even those who
understand option volatility don't coin money......check with Vic
Niederhoffer. ( Those traders who understand option volatility but had the
$1,000,000 plus losses can be forgiven for missing the parties on the Tuesday
night after the market break.)
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