Edge in understanding Distributions?

J

jordanwrong

When assets drop significantly from an event, for example when Equifax had the cyber breach, Skew increases drastically. This is also seen in leap options as well. At this point should'nt the distribution be bi-modal instead of a skew normal distribution? Is there an edge here to buy long dated calls if you believe the company will come out of it. Or at least has a higher prob then the market is pricing?

I hope I can get opinions from @sle and @Maverick74. Thanks
 
SLE has left ET... not sure if he'll be back.

Are we talking about probability distribution, or IV curve?

Bi-modal distributions don't make sense in options... since the payoffs across strikes are all linked to each other. They are linear at expiration... Of course you can estimate the best strike to be long given a certain scenario, but that doesn't mean the calls at lower strikes don't pay out.

Of course you can have a very flat type of IV curve... but that doesn't mean the probability distribution is flat. That's usually in a very high IV across the board.

Or in case of very low volatility, everyone is trying to be short ATM and long wings... so you get a very smiley curve.

Skew can also reverse. OTM calls might have a higher IV than OTM puts. Depending on the scenario, that usually happens in the shorter term options. Long dated ones, especially when in an elevated IV, the calls will still be priced with a slightly lower IV than ATM/OTM puts. That's because eventually, when things normalize, IV should come down again. You would expect the "panic-up" will stop at one point. You want to be long the call spread then... Not just long any OTM calls.
 
jordanwrong said:
When assets drop significantly from an event, for example when Equifax had the cyber breach, Skew increases drastically. This is also seen in leap options as well. At this point should'nt the distribution be bi-modal instead of a skew normal distribution? Is there an edge here to buy long dated calls if you believe the company will come out of it. Or at least has a higher prob then the market is pricing?

I hope I can get opinions from @sle and @Maverick74. Thanks
More...

Upside call vol is sticky when stocks have large drops. Meaning the vol is slow to come down. I suspect this might be because when bad news is announced it can be risky to bottom pick the stock but many will opt to buy the calls. Once the stock settles the upside calls vols tend to come in. If there is any edge here it's probably selling the upside call skew immediately after the selloff and buying the stock and then taking the trade off after the stock stabilizes all things being equal.
 
As long as we're getting opinions from some of the very experienced here.. I have a question.

After reading about options and getting through the initial red herrings, like positive expectancy coming from premium selling, etc, it basically seems like one either needs a way to model direction somewhat accurately, or have some method to determine when premiums tied to volatility have a good chance of being over/under the volatility that is actually realized over the life of the option.

How would you recommend one start going about either of those? Is there a gradient of refinements one can learn to make to optimize a portfolio or is the attitude correct where short of being a full-time, fanatically devoted professional, 99% have no chance of doing better than Buy & Hold over the long-term as probability normalizes?
 
Magic said:
As long as we're getting opinions from some of the very experienced here.. I have a question.

After reading about options and getting through the initial red herrings, like positive expectancy coming from premium selling, etc, it basically seems like one either needs a way to model direction somewhat accurately, or have some method to determine when premiums tied to volatility have a good chance of being over/under the volatility that is actually realized over the life of the option.

How would you recommend one start going about either of those? Is there a gradient of refinements one can learn to make to optimize a portfolio or is the attitude correct where short of being a full-time, fanatically devoted professional, 99% have no chance of doing better than Buy & Hold over the long-term as probability normalizes?
More...

There is an old saying that the only free lunch in finance is diversification. Invest in assets with as little correlation to each other as possible and re-balance when appropriate.
 
:) I don't mind working for pay, but having other responsibilities as well as not knowing how best to apply aptitude toward this problem are some limiting factors at the moment.

I have thought a few times about trying to patch together a reasonably diversified portfolio and lever it up aggressively, knowing I have a decent amount of W-2 income and access to relatively cheap capital to bring to bear if/when size-able DD occurs.

Hard to know when to pull the trigger... but maybe it's time to just go and do it on a smaller scale to see what happens and gain some experience.
 
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