2 Standard Deviation Moves

A purely short position in an option contract is also

known as being naked, this is in reference to its
risk.
Naked risk means there is no defining hedge, such
as stock, or a long option against the short option.
Hence the max potential loss is unknown.

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2 Standard Deviation Moves

When selling a naked put, we know that the max
loss is not infinite as the underlying can only fall to
zero.
However, when we sell a call, is the realistic max
loss actually infinite?

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2 Standard Deviation Moves

More realistically, we look at undefined risk as
being a 2 standard deviation move.
This is because an underlying should stay within 2
standard deviations 95% of the time.
2 Standard deviations equates to selling a 97.5%
Out-the-money (OTM) call and put.

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2 Standard Deviation Moves

To better understand where the true risk lies in undefined
trades, we tested selling premium at the 2 standard
deviation level:
! SPX
! 5 Years
! 1st Day of the month
! 45 Days until Expiration
! Sold 2 Standard Deviation
Strangle
! 97.5% OTM Call and Put
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2 Standard Deviation Moves

SPX 2SD Strangles

P/L

# of Wins

% Wins

Expected %

$10,347.50

60/60

100%

95%

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2 Standard Deviation Moves

Lets consider two standard deviation
Moves in the S&P 500 (SPX) as calculated
by the volatility index (VIX)

2 x SPX x VIX x (Days Un1l Expira1on / 365)

We did this from 1990 to present,
calculating the expected move 45 days out.

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2 Standard Deviation Moves

SPX 2 Standard Deviation Moves Expected vs. Actual Moves
DTE

Occurrences

Expected Occurrences
Outside Range

Actual Occurrences
Outside Range

45

6188

301 (5%)

59 (0.95%)

Average
Expected Move

Average Actual Move

14.06%

4.07%
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2 Standard Deviation Moves

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