Option Trade

Just a quick update today, based on a trade I made. Since my SPY put expired a week ago, I've been looking to buy back in. This is what I did.

Trade: buy 1% (of my portfolio) position in SPY Jan11 91 puts.

*Warning: this is a very risky, out of the money option that may not be appropriate for most investors.

The reason I bought this option is because of my opinion that the global slowdown in fiscal and monetary stimulus over the past 8 months will deflate equity prices.
With this option, I extended the maturity out almost 5 months. I picked the $91 strike price as an extremely speculative bet on a "fat tail." Now, I'm not an options expert by any stretch of the imagination, so this is more of an experiment than anything else. As such, I welcome any suggestions for better ways to capitalize on "fat tails" or other ways to exploit weaknesses in traditional pricing models.

I'm going to get a little technical here. The term "fat tail" refers to a non-normal distribution curve with a higher probability of extreme price movements. The difference between these distribution curves is pictured below.

The chart shows portfolio returns, but the same concept can be applied to options. Most stock and option pricing models used by traders assume a normal distribution. But history proves that price changes are more extreme than a normal distribution predicts. The Y-axis is the number of standard deviations from the mean. The X-axis is the probability of occurrance. The option I bought is at -1 standard deviation, which implies a normal distribution probability of about ~30%. But I think the market is more likely to fall than rise, so the option is most likely cheaper than it should be.