Standard Deviation for Profitable Investing
Stock price moves up and down based on company or economic news. It is difficult to predict the direction of a stock price.
When using stock options you have to put up less capital an have much leverage.
How do we use standard deviation in our trading decisions? SD shown as sigma symbol is a measure of variability or dispersion of a data point from the mean or average of a set of data or time series. A high value denotes more variance from the mean. Conversely, a low number indicates the closeness of a data point from the mean or expected value.
If you assume a stock’s closing prices are random and submit to a normal distribution, then you can utilize stock price vacillations around its mean to make some profitable trading decisions.
SD for profitable Investing and strike selection
Standard deviation can project the probability of a stock price movement around its mean price. For instance, if the mean of closing prices for stock A is $25 and its sigma is $1, then one sigma indicates 68 percent of probability that the next closing price may be between $24 and $26. While 2x sigma projects with 95 percent probability that next closing price may be at $23 to $27. Finally, 3x sigma states with 99 percent probability that the next closing price can be between $22 and $28.
Implied volatility in trading shows us the expected one Standard Deviation move within one year. An underlying with high IV will have a large Standard Deviation, and an underlying with low IV will have a small SD. It is important to note the difference between SD probabilities
and ITM/OTM probabilities. In trading, these differ because SD probabilities look at the whole bell curve, while ITM/OTM options only look at one side. A one SD strangle will have a 16% ITM for each leg, adding up to 32%. 100 – 32 = 68, which is where our 1 SD probability lies.
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At SellOptionPremium.com, we open trade positions one SD away from the stock price. This provides us a higher change of profit. We love periods of high IV because it increases the credit we receive from option price inflation and allows us to move further away from the stock price.
We like to sell Options for profitable investing, so that we receive Option Premium. Typically we do not wait until expiration but we exit the Trade at 50% of maximum profit. This will increase the number of winning trades and it will increase our portfolio too.