Alert

Looking to access our full catalog of shows? Log in to see what's recent and get old favorites!

Standard Deviation

In statistics, standard deviation is a unit of measurement that quantifies certain outcomes relative to the average outcome.

Before diving into how it applies to options trading, it’s important to understand the probabilities associated with certain multiples of standard deviations:
- 1 standard deviation encompasses approximately 68.2% of outcomes in a distribution of occurrences
- 2 standard deviations encompasses approximately 95.4% of outcomes in a distribution of occurrences
- 3 standard deviations encompasses approximately 99.7% of outcomes in a distribution of occurrences

The standard deviation of a particular stock can be quantified by examining the implied volatility of the stock’s options. The implied volatility of a stock is synonymous with a one standard deviation range in that stock.

For example, if a $100 stock is trading with a 20% implied volatility, the standard deviation ranges are:
- Between $80 and $120 for 1 standard deviation
- Between $60 and $140 for 2 standard deviations
- Between $40 and $160 for 3 standard deviations

From this, we can conclude that market participants are pricing in a:
- 68% probability of the stock closing between $80 and $120 a year from now
- 95% probability of the stock closing between $60 and $140 a year from now
- 99.7% probability of the stock closing between $40 and $160 a year from now

How do we capture all of this with options trading? We just need to remember a few probabilities in our strike prices:
- Strikes with a probability of 16% ITM / 84% OTM capture a 1 standard deviation range for an OTM option
- Strikes with a probability of 2.5% ITM / 97.5% OTM capture a 2 standard deviation range for an OTM option

It’s important to note these values are just for one side. For a strangle where we’re selling an OTM put and an OTM call together, we look for 16% ITM probabilities on either side, which gives us that 68% probability of the stock closing within that range (16 + 16 = 32. 100-32 = 68%). One cool thing about standard deviation & implied volatility is that when IV is high, we can obtain these probabilities using much wider strikes. Implied volatility is high, which means there is a larger implied range the stock can move. That directly translates to higher probabilities of being ITM for further out strikes. That’s the power of high implied volatility!

As we can see, understanding what implied volatility is telling you about a stock’s expected future movements is very valuable!

Market Data provided by CME Group & powered by dxFeed Technology. Options involve risk and are not suitable for all investors.
Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

tastytrade content is provided solely by tastytrade, Inc. (“tastytrade”) and is for informational and educational purposes only. It is not, nor is it intended to be, trading or investment advice or a recommendation that any security, futures contract, transaction or investment strategy is suitable for any person. Trading securities can involve high risk and the loss of any funds invested. tastytrade, through its content, financial programming or otherwise, does not provide investment or financial advice or make investment recommendations. Investment information provided may not be appropriate for all investors, and is provided without respect to individual investor financial sophistication, financial situation, investing time horizon or risk tolerance. tastytrade is not in the business of transacting securities trades, nor does it direct client commodity accounts or give commodity trading advice tailored to any particular client’s situation or investment objectives. Supporting documentation for any claims (including claims made on behalf of options programs), comparison, statistics, or other technical data, if applicable, will be supplied upon request. tastytrade is not a licensed financial advisor, registered investment advisor, or a registered broker-dealer. Options, futures and futures options are not suitable for all investors. Prior to trading securities products, please read the Characteristics and Risks of Standardized Options and the Risk Disclosure for Futures and Options found on tastyworks.com.

tastyworks, Inc. ("tastyworks") is a registered broker-dealer and member of FINRA, NFA and SIPC. tastyworks offers self-directed brokerage accounts to its customers. tastyworks does not give financial or trading advice nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of tastyworks’ systems, services or products. tastyworks is a wholly owned subsidiary of tastytrade, Inc (“tastytrade”). tastytrade is a trademark/servicemark owned by tastytrade.

Quiet Foundation, Inc. (“Quiet Foundation”) is a wholly-owned subsidiary of tastytrade The information on quietfoundation.com is intended for U.S. residents only. All investing involves the risk of loss. Past performance is not a guarantee of future results. Quiet Foundation does not make suitability determinations, nor does it make investment recommendations. You alone are responsible for making your investment and trading decisions and for evaluating the merits and risks associated with the use of Quiet Foundation’s systems, services or products.

Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information on this site should be considered general information and not in any case as a recommendation or advice concerning investment decisions. The reader itself is responsible for the risks associated with an investment decision based on the information stated in this material in light of his or her specific circumstances. The information on this website is for informational purposes only, and does not contend to address the financial objectives, situation, or specific needs of any individual investor. Trading in derivatives and other financial instruments involves risk, please read the Risk Disclosure Statement for Futures and Options. tastytrade is an investor in Small Exchange, Inc.

© copyright 2013 – 2021 tastytrade. All Rights Reserved. Applicable portions of the Terms of use on tastytrade.com apply. Reproduction, adaptation, distribution, public display, exhibition for profit, or storage in any electronic storage media in whole or in part is prohibited under penalty of law, provided that you may download tastytrade’s podcasts as necessary to view for personal use.