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Bob:
I think Paul's point was predicated on the difference between Implied Volatility and Historical Volatility.
If IV is high compared to its usual range, and IV is significantly higher than HV (which is quite common), then you can sell options at 2, or even three sigmas out, assuming that you calculate the standard deviation using the HV. In this way, you collect an agreeable amount of premium (thanks to the high IV) and you have a theoretical 90 - 95% chance of the options expiring worthless.
What is more, IV and HV both have a tendency to revert to their means. Thus if the IV is seriously high (in the top decile of all recordiings over the last couple of years, for instance) then the likelihood is that it will top out and turn lower. Lower volatility obviously favors a short option position.
- Stuart
>>> <RJones2279@xxxxxxx> 07/22 4:43 AM >>>
Hi,
Being another novice I was interested in Pauls comments.
I would have thought that with IV being high the SD will of course also be
high and I would have thought that there would be very few occasions where
options could be written 3-4 SD's from the money. In any case the premiums
would be very low and it is a legitimate question as to whether it is worth
the (admittedly)low theoretical risk of being caught out by an explosive price
movement. The problem with probability is that a one in a million chance is
assumed to be "way out there" and something we need not pay too much attention
to; the irritating fact is that the unexpected may be the next thing to
happen.
With a straight strangle this problem is mitigated but is obviously more
probematical witha ratio spread.
As has been commented previously the risk may be in practice assymetrical (
the S & P is far more likely to suffer a quick sharp decline than a sudden
rise of the same magnitude; some of the agriculturals are much more likely to
have a precipitous rise- frosts in Brazil).
An interesting discussion.
Thanks
Bob Jones
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