36 lines
2.8 KiB
Plaintext
36 lines
2.8 KiB
Plaintext
Chapter 38: The Distribution of Stock Prices 795
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Figure 38-3 perhaps shows even more starkly how the bull market has affected
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things over the last six-plus years. There are over 1,600 data points for IBM (i.e., daily
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readings) in Figure 38-3, yet the whole distribution is skewed to the right. It appar
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ently was able to move up quite easily throughout this time period. In fact, the worst
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move that occurred was one move of -2.5 standard deviations, while there were
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about ten moves of +4.0 standard deviations or more.
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For a longer-term look at how IBM behaves, consider the longer-term distribu
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tion of IBM prices, going back to March 1987, as shown in Figure 38-4.
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From Figure 38-4, it's clear that this longer-term distribution conforms more
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closely to the normal distribution in that it has a sort of symmetrical look, as opposed
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to Figure 38-3, which is clearly biased to the right (upside).
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These two graphs have implications for the big picture study shown in Figure
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38-1. The database used for this study had data for most stocks only going back to
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1993 (IBM is one of the exceptions); but if the broad study of all stocks were run
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using data all the way back to 1987, it is certain that the "actual" price distribution
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would be more evenly centered, as opposed to its justification to the right (upside).
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That's because there would be more bearish periods in the longer study (1987, 1989,
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and 1990 all had some rather nasty periods). Still, this doesn't detract from the basic
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premise that stocks can move farther than the normal distribution would indicate.
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WHAT THIS MEANS FOR OPTION TRADERS
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The most obvious thing that an option trader can learn from these distributions and
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studies is that buying options is probably a lot more feasible than conventional wisdom
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would have you believe. The old thinking that selling an option is "best" because it
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wastes away every day is false. In reality, when you have sold an option, you are exposed
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to adverse price movements and adverse movements in implied volatility all during the
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life of the option. The likelihood of those occurring is great, and they generally have
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more influence on the price of the aption in the short run than does time decay.
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You might ask, "But doesn't all the volatility in 1999 and 2000 just distort the
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figures, making the big moves more likely than they ever were, and possibly ever will
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be again?" The answer to that is a resounding, "Nol" The reason is that the current
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20-day historical volatility was used on each day of the study in order to determine
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how many standard deviations each stock moved. So, in 1999 and 2000, that histori
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cal volatility was a high number and it therefore means that the stock would have had
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to move a very long way to move four standard deviations. In 1993, however, when
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the market was in the doldrums, historical volatility was low, and so a much smaller |