On this page
What this one covers
- Stock picking bets on a future price move that the efficient market hypothesis says is already priced
- Historical volatility measures how much the stock moved over a chosen window, 30, 100 or 1,000 days
- Implied volatility is the one unknown input to Black-Scholes, so traders set it
- When implied sits above historical, the trade described is to sell the option and wait for vol to mean revert
The same thing, in writing
Why stock picking is not the edge
A lot of people try to pick stocks in the belief that there is an edge in doing so. Under the efficient market hypothesis, which this video accepts, all known information is already reflected in a stock's current price. Picking a stock is therefore a bet on a future price move, and nothing in the known information gives that bet an edge.
Where the statistical edge sits
The statistical edge sits in the difference between historical volatility and the implied volatility inside an options contract. Historical volatility is how much the stock has moved over a chosen window, whether that is 30 days, 100 days or 1,000 days. Implied volatility covers a similar term, and it is the one unknown input to the Black-Scholes model, so it is set by traders rather than by the stock's past.
The trade that follows
When implied volatility is priced above the historical volatility of the option, the trade the video describes is to sell that option and wait for volatility to mean revert before exiting the position.
Topics
- volatility risk premium
- implied volatility
- historical volatility
- efficient market hypothesis
- quick tip
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Where this one
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