Question about standard deviation

Lightspeed said: "Can anyone explain to me what standard deviation is? Also, how can I apply this knowledge to my credit spreads or the straight puts and calls? Basically, how do I correlate this info to the real trade. Thanks in advance guys! :)"

roarflolo said: "[URL="http://en.wikipedia.org/wiki/Standard_deviation"]http://en.wikipedia.org/wiki/Standard_deviation[/URL] For [URL="http://en.wikipedia.org/wiki/Standard_deviation#Rules_for_normally_distributed_data"]Normally distributed data[/URL] the 1st standard deviation accounts for ~68% of the data set. So, assuming stock price movement is "normally distributed", you "know" that a stock will move within one standard deviation 68% of the time. Using the stock volatility you can figure out how much the stock is expected to move over a time-period, e.g. 30 days: [INDENT]deviation = (Price * V) / sqrt( X ) V is the at-the-money Call Implied Volatility X is 52 (weekly), 12 (monthly), 6 (bi-monthly) [/INDENT] You can use this to increase your odds... assuming all the assumptions are correct :laugh:"

Lightspeed said: "[QUOTE=roarflolo][URL="http://en.wikipedia.org/wiki/Standard_deviation"]http://en.wikipedia.org/wiki/Standard_deviation[/URL] For [URL="http://en.wikipedia.org/wiki/Standard_deviation#Rules_for_normally_distributed_data"]Normally distributed data[/URL] the 1st standard deviation accounts for ~68% of the data set. So, assuming stock price movement is "normally distributed", you "know" that a stock will move within one standard deviation 68% of the time. Using the stock volatility you can figure out how much the stock is expected to move over a time-period, e.g. 30 days: [INDENT]deviation = (Price * V) / sqrt( X ) V is the at-the-money Call Implied Volatility X is 52 (weekly), 12 (monthly), 6 (bi-monthly) [/INDENT] You can use this to increase your odds... assuming all the assumptions are correct :laugh:[/QUOTE] _____________________________________ Ohhhh Kaaayyyy :whacky028: .......one more time in English? Lol."

roarflolo said: "What about an example... Take a stock XYZ trading at $100 and implied volatility is 30%. One standard deviation for a 30 day period is: [INDENT]deviation = (100*0.30) / sqrt( 12 ) = 8.66[/INDENT] That means the expected price range over the next month is 91.34 to 108.66 with ~68% probability. You can use this to place a put-vertical with the short strike at 90 and/or a call-vertical with the short strike at 110 and have a ~68% probability that it will trade between those short strikes in the next 30 days. Probably. Definitely not a mathematical certainty. You can still easily get 5,6,7 or more moves beyond that range during a year, "random" as it is. Read up on Wikipedia link I posted and statistics as well."

Lightspeed said: "[QUOTE=roarflolo]What about an example... Take a stock XYZ trading at $100 and implied volatility is 30%. One standard deviation for a 30 day period is: [INDENT]deviation = (100*0.30) / sqrt( 12 ) = 8.66[/INDENT] That means the expected price range over the next month is 91.34 to 108.66 with ~68% probability. You can use this to place a put-vertical with the short strike at 90 and/or a call-vertical with the short strike at 110 and have a ~68% probability that it will trade between those short strikes in the next 30 days. Probably. Definitely not a mathematical certainty. You can still easily get 5,6,7 or more moves beyond that range during a year, "random" as it is. Read up on Wikipedia link I posted and statistics as well.[/QUOTE] Whoa!! Now that makes a lot of sense! I can see how knowing this fact gives one (ie, me) a much better perspective of how a spread might go. Kinda like a much brighter torch in the dark. Much easier and clearer to find and set boundaires. How did you come up with 68% probability and why divide by the square root of 12? Thanks Buddy!!:not_worthy:"

Lightspeed said: "[QUOTE=roarflolo]What about an example... Take a stock XYZ trading at $100 and implied volatility is 30%. One standard deviation for a 30 day period is: [INDENT]deviation = (100*0.30) / sqrt( 12 ) = 8.66[/INDENT] That means the expected price range over the next month is 91.34 to 108.66 with ~68% probability. You can use this to place a put-vertical with the short strike at 90 and/or a call-vertical with the short strike at 110 and have a ~68% probability that it will trade between those short strikes in the next 30 days. Probably. Definitely not a mathematical certainty. You can still easily get 5,6,7 or more moves beyond that range during a year, "random" as it is. Read up on Wikipedia link I posted and statistics as well.[/QUOTE] One more observation, the deviation is based upon the premise that the volatility and stock price remains the same. So if I am placing a spread order one day with a sense of where it could move, that may all change the next day. Doesn't that just nullifies it all? On another note, I was reading one comment on the board a while back that said as time decay affects the option price, the devaition will decrease as the volatility decreases as well. Is that correct? So the probability of the option to go pass the strike of the spread is lessened. True?"

roarflolo said: "The square root of 12 is the time aspect, i.e. how far ahead you want to look. [INDENT]X is 52 (weekly), 12 (monthly), 6 (bi-monthly)[/INDENT] 52 is simply 365 days divided by 7 days, i.e. one week 12 is simply 365 days divided by 30 days, i.e. one month etc. The STDEV (standard deviation) is based on volatility and time. Time is easy, it'll change the same every day. Volatility will change as the market predicts movements. You can compare the at-the-money Implied Volatility of the front-month and one month out to see if there is a large skew, if it is, something is going on. If you look at the way the standard deviation is calculated: [INDENT]STDEV = (Price * V) / sqrt( X )[/INDENT] As time moves on, sqrt(X) increases: [INDENT]30 days out: sqrt(365/30) = 3.464 15 days out: sqrt(365/15) = 4.932 7 days out: sqrt(365/7) = 7.22[/INDENT] So the result is a smaller standard deviation a shorter time out. It makes sense; it's more likely that you have a N point move over the next 300 days than it is over the next 7 days. Volatility plays into this. If you look at the sqrt(X) you'll see it roughly doubled from 30 days out to 7 days out so the STDEV would be about half (if Price and Volatility are unchanged) If the (Price*V) doubled as well, the 7-day standard deviation would be roughly equal to the 30-day standard deviation. The 68% probability comes from the Wikipedia link I posted about the standard deviation."