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What is Tail Risk?
Tail Risk The risk of extreme market events that lie in the tails of the probability distribution, occurring more frequently than a normal distribution predicts (fat tails). Options premium sellers are particularly exposed to tail risk because large, sudden moves can generate losses many times greater than the premium collected. Tail risk hedges (like OTM puts) protect against these events.
Complete definition
The risk of extreme market events that lie in the tails of the probability distribution, occurring more frequently than a normal distribution predicts (fat tails). Options premium sellers are particularly exposed to tail risk because large, sudden moves can generate losses many times greater than the premium collected. Tail risk hedges (like OTM puts) protect against these events.
Example
The 2020 COVID crash was a tail event. Stocks dropped 35% in weeks, devastating premium sellers who were short puts without protection.
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