830 Part VI: Measuring and Trading Volatility 
Example: A trader is considering the purchase of the XYZ October 40 straddle for 
11 points, with the stock at 39.60. The options are cheap and the probabilities of suc­
cess appear to be good, according to the probability calculator. The question that now 
needs to be asked and answered is this: "In the past, has this stock been able to move 
11 points in 10 months (the time remaining in the straddle's life)?" Or, more impor­
tantly, since 11 divided by 39.60 is about 28%, "Has this stock been able to make 
moves of 28% over 10 months, in the past?" The answers to these questions can be 
readily obtained if stock price history data is available. One could even look at a chart 
of the stock and attempt to answer the questions himself without the aid of a com­
puter, but computer analysis of the price history is more rigorous and is therefore 
encouraged. 
The answers can be expressed in the form of probabilities, much as the results 
of the probability calculator are. 
Suppose one determines that the stock has been able to move 11 points in 10 
months 77% of the time in the past. That's okay, but not great. However, when one 
looks at the price chart ofXYZ, he sees that it traded at much lower prices - near $10 
a share - for a long time before rising to its current levels. It would be very hard to 
expect a $10 stock to move 11 points in 10 months. That's why the second figure, the 
one involving the 28% move, is the more significant one. In this case, one might find 
that XYZ has been able to move 28% in 10 months over 90% of the time in the past. 
Now one has what appears to be a decent-looking straddle buy. 
This analysis of past prices can be done in a more sophisticated manner. Rather than 
just asking whether or not the stock has moved the required distance in the past, one 
might want to see just how the stock's movements "look." That is, there are a couple 
of scenarios under which the past movements might look attractive, but upon closer 
examination, one would not be so sanguine. 
For example, what ifXYZ had repeatedly moved 28%, but never much more in 
most of the IO-month periods that comprise its stock history? Then, one would be 
less inclined to want to own this straddle. 
Another scenario of past movements might be that XYZ had made moves that 
one could not reasonably expect to be repeated. Perhaps there was a huge gap down 
on an earnings shortfall, or if it was an Internet stock around the tum of the millen­
nium, it had a huge move upward, followed by a huge move downward. That would 
be another nonrepeating type of move, because absent the Internet mania, the stock 
might have been a rather range-bound item both prior to and after the one huge, 
round-trip move.