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The Skinny on Options: Abstract Applications

ARCH Models

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.

High level math and statistics doesn’t have to be purely theoretical, with no applicability to us in our everyday trading. When understood correctly, some of the more complex models in those fields can help bolster our foundational understanding as traders. Case in point - ARCH modeling. An ARCH model, or autoregressive conditional heteroskedasticity, helps us better understand how volatility changes over time. As tastytraders, this is incredibly important because a core principle to our overall strategy is implied volatility rank.

Well, not only does an ARCH model help us better appreciate volatility, but it can also help explain the positive kurtosis we observe in the marketplace. We’ve always known what positive kurtosis is, but now we can begin to see why it’s there.

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