The Skinny on Options: Abstract Applications

The Central Limit Theorem

The Skinny on Options: Abstract Applications

Options involve risk and are not suitable for all investors. Please read Characteristics and Risks of Standardized Options before deciding to invest in options.

As tastytraders, we like to utilize statistics as the ultimate governor of our approach to trading. The core pillars of our philosophy, such as managing winners, duration over direction, or trade small, trade often, are all rooted in mathematical principles and quantitative reasoning. The Central Limit Theorem, one of the most widely used theories in all of statistics, lends incredible support to that final pillar.

Specifically, not only does the Central Limit Theorem reinforce the accuracy and reliability of the Normal Distribution, but it also speaks directly to the relevancy of the Normal Distribution to us as traders. First, the Central Limit Theorem shows us that regardless of your population’s distribution, the distribution of the samples you might pull from that population will approach a Normal Distribution, given enough observations. As traders who focus on repeated trades in the 45 DTE window, this is hugely important. Second, we see that if you drive your number of observations high enough, the Central Limit Theorem shows us that the variance, or standard deviation, around your expectations will asymptotically approach zero.

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