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

CHAPTER 7

Risk and Psychology of Investing and Spread Trading

Risk is classically defined as the chance that an event, such as an actual return on an investment, will be different than expected. It is generally measured, as we will see in the next chapter, by mean or average returns and computation of the standard deviation of the average. The higher the standard deviation, the higher the risk. A zero standard deviation implies no risk, further implying perfect foresight, which no person has.

Modern portfolio theory and the efficient market hypothesis, also examined at some length in the next chapter, assume that investors are rational mean-variance optimizers. That rather fancy sounding phrase means that, as investors, we intelligently and coolly gather all available facts, assess all possible outcomes and chances of random events that may impact our assumptions, and then make the optimal decision like a chess grandmaster as we make investments and trades.

■ An Introduction to Risk

A little bit about us. Scott is a very sharp guy, holds a master's degree from the University of Georgia, is a CPA, and has worked in a number of very high-level business positions prior to entering academia. Charles holds a doctorate in business with a double major in accounting and finance from Argosy University; is a Chartered Financial Analyst (CFA), a CFP, and a CPA; and also holds a long résumé in financial and investment planning and primarily small business valuation prior to joining the ranks ...