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What Is Undefined? - Jan 27, 2015 | Market Measures
Find out what the risk actually is of an undefined risk trade and how often this level is actually breached!
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      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.
      Market Measures

      What Is Undefined?

      Jan 27, 2015

      When trading an undefined risk trade, the max loss is assumed to be unlimited. This is because if you are short a call, the underlying to go up indefinitely. However if this was actually the case, why would a broker ever let you place an undefined risk trade?

      Today, Tom Sosnoff and Tony Battista look to put some context around what the risk of an undefined trade actually is. Brokerage firms usually use the margin requirement of a 2 standard deviation move for these types of trades. The guys then look at a couple of studies around these levels. First they look at how placing a 2 standard deviation strangle would have performed from 2008 - Present. They find that if you would have placed these trades, there would have only been 1 loss over 84 occurrences.

      Next, they look at a rolling window of time to see the number of times that the 2 standard deviation level was breached. The guys go back to 1990 and find out that there have been 59 times that the 2 standard deviation level was breached. They wanted to take this one step further and see the number of times it was breached to the upside and to the downside. Surprisingly, Tom and Tony find that 57 of the 59 breaches came to the downside and 33% of these came during October of 2008!

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