Stuck in the Middle with You
Why can’t I get the song “Stuck in the Middle With You” by the band Stealers Wheel out of my head? I wasn’t even around when it was popular, and I don’t enjoy the rest of the band’s music, but it still hums in the back of my mind during the trading day.
It has a lot to do with tail hedging.
Skilled option traders select trades based on market conditions. If implied volatility is depressed, calendar spreads have a good risk reward payoff. If implied volatility is expensive, a butterfly spread might make sense.
Placing bets on tails, the large and rare moves in the market, require strategies that are a little more complex than simple butterflies or calendar spreads.
Why?
Stealers Wheel
This gets back to my Stuck in the Middle with You affliction. The stock market has a lot of quiet times, it’s stuck in the middle a lot. Large movements in prices are rare. In fact, the Covid 19 crash was one of the few large price movements in history.
So, to be successful in tail hedging, we need to have a strategy that acknowledges the quiet times, the stuck in the middle times, and the rare times when the market has enormous price movement.
If this was a Stealers Wheels song, this might be called “Moving Rapidly Away From the Middle With You.”
Best,
James
