Charles Conrick IV - Vertical Option Spreads, + Website: A Study of the 1.8 Standard Deviation Inflection Point

CONTENTS

V ERTICAL O PTION S PREADS

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V ERTICAL
O PTION
S PREADS

A Study of the 1.8 Standard
Deviation Inflection Point

Charles Conrick IV

Scott Hanson

Cover image: iStockphoto.com/axllll
Cover design: Wiley

Copyright 2013 by Dr. Charles Conrick IV and Scott Hanson. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.
Published simultaneously in Canada.

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ISBN 978-1-118-53700-8 (cloth)
ISBN 978-1-118-74693-6 (ebk)
ISBN 978-1-118-73969-3 (ebk)

To our mothers and wives

PREFACE

V ertical Option Spreads results from extensive study and actual trading of the Standard & Poor's 500 exchange-traded fund (ETF) SPY over the past five years. We are professors of finance and accounting at Dickinson State University in western North Dakota and are both experienced investors and options traders knowledgeable of both the theory of derivative pricing and the practicalities of online trading.

Having read many of the fine texts and books on using options to enhance returns in these days of volatile markets and the past decade of little to negative returns using the twentieth-century model of buy and hold, we set out in 2009 on a journey to attempt to find a way to marry the concept of probability under finite time conditions to a rationally measured return. The introduction of the new weekly options issued by the Chicago Board Options Exchange (CBOE) in June 2010 provided the ideal vehicle for the concept. As said, there are a number of fine books advising investors on managing the many types of option strategies. However, probability theory seemed to be lacking in many of these books insofar as direct quantification of such probabilities.

The recent challenge of exactly how well market returns do fit the normal distribution being raised by advocates of fractal mathematics and chaos theory throws more confusion at an investor: If market returns do not actually conform to the normal distribution, how does a trader actually predict the probability of a trade winning or losing using conventional statistics?

We have attempted to solve this conundrum by using five years of weekly data to ascertain exactly how various debit and credit spreads, as well as their combinations called butterflies and condors, have actually performed under re-created conditions. Additionally, the use of Oracle's Crystal Ball enables us to re-create and run thousands of simulations to predict future trade probabilities under various scenarios. These results and simulations provide what we believe to be a bona fide, rational trading system whereby the vagaries of the market can be estimated under a very small margin of error. Thus, like any other trading system, it possesses the risk of the unknown or the black swan events, but finally offers a thorough, understandable, and probabilistic trading system for the average and sophisticated investor.

Compliments of the Crystal Ball Education Initiative

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