Viewers new to tastylive might not know what Kurtosis is but veteran viewers know that it means that market returns have fatter tails than the normal distribution curve. Market participants know this too and as a result they often bid up out-of-the-money (OTM) options beyond what the Options Models (eg. Black-Scholes) value them. TP joins the guys to explain these concepts and what we can learn from them.
Those bidding up the options estimate the expected move will be greater than what the Model predicts. This impacts Implied Volatility (IV) and is why we see Volatility Skew. The higher demand for the options increases the price and the increased price means increased IV. This is why an option’s IV is an interpretation of its price, all other things being the same.
TP explained the IV calculation. He then elaborated and described how we use the changing IV figure to calculate probabilities and Greeks. He then further explained how we can also price the theoretical value of the option using IV, that makes its probability of expiring OTM, match the Kurtosis curve and compare the historical distribution to the market. A table listed SPY Puts and Calls that were 1%, 2%, 5% and 10% OTM. The table listed the Kurtosis theoretical value, the market price and the percentage the market price was over Kurtosis. TP used the table to show, “that based on the real fat tails that we've seen and the Kurtosis behavior of the market, that the IV that would have generated those sorts of returns. The risk premium that is embedded in options we know is always overstated and this emphasizes the point." Summing things up TP said, “My point is not that these options are overpriced. The takeaway here is you are worried about risk and you are buying insurance. What is that insurance really worth versus what they are charging you for it?”
For more information on Kurtosis see:
The Skinny On Options Math from June 13, 2013: "Kurtosis"
From Theory To Practice from August 19, 2016: "The Probabilities of the Normal Distribution"
From Theory To Practice from August 19, 2016: "Kurtosis Revisited"
Watch this segment of The Skinny On Options Modeling with Tom Sosnoff, Tony Battista and Tom Preston (TP) for the key takeaways and a better understanding of Kurtosis and why since “fear is overstated” option prices tend to be overstated.
This video and its content are provided solely by tastylive, Inc. (“tastylive”) and are for informational and educational purposes only. tastylive was previously known as tastytrade, Inc. (“tastytrade”). This video and its content were created prior to the legal name change of tastylive. As a result, this video may reference tastytrade, its prior legal name.
tastylive content is created, produced, and provided solely by tastylive, Inc. (“tastylive”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, digital asset, other product, transaction, or investment strategy is suitable for any person. Trading securities, futures products, and digital assets involve risk and may result in a loss greater than the original amount invested. tastylive, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastylive is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparisons, statistics, or other technical data, if applicable, will be supplied upon request. tastylive is not a licensed financial adviser, registered investment adviser, or a registered broker-dealer. Options, futures, and futures options are not suitable for all investors. Prior to trading securities, options, futures, or futures options, please read the applicable risk disclosures, including, but not limited to, the Characteristics and Risks of Standardized Options Disclosure and the Futures and Exchange-Traded Options Risk Disclosure found on tastytrade.com/disclosures.
tastytrade, Inc. ("tastytrade”) is a registered broker-dealer and member of FINRA, NFA, and SIPC. tastytrade was previously known as tastyworks, Inc. (“tastyworks”). tastytrade offers self-directed brokerage accounts to its customers. tastytrade does not give financial or trading advice, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastytrade’s systems, services or products. tastytrade is a wholly-owned subsidiary of tastylive, Inc.
tastytrade has entered into a Marketing Agreement with tastylive (“Marketing Agent”) whereby tastytrade pays compensation to Marketing Agent to recommend tastytrade’s brokerage services. The existence of this Marketing Agreement should not be deemed as an endorsement or recommendation of Marketing Agent by tastytrade. tastytrade and Marketing Agent are separate entities with their own products and services. tastylive is the parent company of tastytrade.
tastycrypto is provided solely by tasty Software Solutions, LLC. tasty Software Solutions, LLC is a separate but affiliate company of tastylive, Inc. Neither tastylive nor any of its affiliates are responsible for the products or services provided by tasty Software Solutions, LLC. Cryptocurrency trading is not suitable for all investors due to the number of risks involved. The value of any cryptocurrency, including digital assets pegged to fiat currency, commodities, or any other asset, may go to zero.
© copyright 2013 - 2024 tastylive, Inc. All Rights Reserved. Applicable portions of the Terms of Use on tastylive.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastylive’s podcasts as necessary to view for personal use. tastylive was previously known as tastytrade, Inc. tastylive is a trademark/servicemark owned by tastylive, Inc.