788 Part VI: Measuring and Trading VolatiDty 
ally including gap moves. There are not always gap moves, though, over a study of 
this length. Sometimes, there will be a more gradual transition. Consider the fact that 
one of the stocks in the study moved 5.8 sigma in the 30 days. There weren't any huge 
gaps during that time, but anyone who was short calls while the stock made its run 
surely didn't think it was a gradual advance. 
So, what does this information mean to the average option trader? For one, 
you should certainly think twice about selling stock options in a potentially volatile 
market ( or any market, for that matter, since these large moves are not by any means 
limited to the volatile market periods). This statement encompasses naked option 
selling, but also includes many forms of option selling, because of the possibilities of 
large moves by the underlying stocks. 
For example, covered call writing is considered to be "conservative." However, 
when the stock has the potential to make these big moves, it will either cause one to 
give up large upside profits or to suffer large downside losses. ( Covered call writing 
has limited profit potential and relatively large downside risk, as does its equivalent 
strategy, naked put selling.) When these large stock moves occur on the upside, a cov­
ered writer is often disappointed that he gave up too much of the upside profit poten­
tial. Conversely, if the stock drops quickly, and one is assigned on his naked put, he 
often no longer has much appetite for acquiring the stock ( even though he said he 
"wouldn't mind" doing so when he sold the puts to begin with). 
Even spreading has problems along these lines. For example, a vertical spread 
limits profits so that one can't participate in these relatively frequent large stock 
moves when they occur. 
What can an option seller do? First, he must carefully analyze his position and 
allow for much larger stock movements than one would expect under the lognormal 
distribution. Also, he must be careful to sell options only when they are expensive in 
terms of implied volatility, so that any decrease in implied will work in his favor. 
Probably most judicious, though, is that an option seller should really concentrate on 
indices (or perhaps certain futures contracts), because they are statistically much less 
volatile than stocks. Hard as it is to believe, futures are less volatile than stocks 
(although the leverage available in futures can make them a riskier investment overall). 
Two 30-day studies, similar to those conducted on stocks, were run on option­
able indices, covering the same time periods: 10/22/99 to 12/7/99 for one study and 
7/1/93 to 8/17/93 for the other. The results are shown in Tables 38-5 and 38-6. This 
may be a somewhat distorted picture, though, because many of these indices overlap 
(there are four Internet indices, for example). The largest mover was the Morgan 
Stanley High-Tech Index (5 standard deviations), but it should also be noted that 
something that is considered fairly tame, such as the Russell 2000 ($RUT), also had 
a 3-standard deviation move in one study. The first study showed that 37% of the