Facebook’s 4 Sigma Event – $1K Strike now Worth $220kGuest Post
Article by RCM Alternatives
If you haven’t heard yet – the most popular social media network in the world (arguably) didn’t have a great earnings report last night, and its stock is having its single largest loss in the stock’s history – down about $45 or -22 %. But we aren’t here to discuss why the stock fell the way it did (if we had to guess, its because kids don’t want to be on a social network with their mom’s and grandmas), but we are interested in the drop itself. Turns out, Facebook’s move is a 4 sigma event.
Sigma simply means the number of stand deviations the move is outside the “norm”, with the norm meaning a normally distributed data set. Normally distributed is a statistical term meaning that any observations we see in a data set will be in a bell curve shape, with roughly 68% of the data points being 1 standard deviation above or below the average, and 95% being within 2 standard deviations of the average, and virtually no data points outside of 3 standard deviations above or below the average (just .027% of the observations).
We often get surprised by the market’s multi-sigma events, but this is nothing new. Markets are NOT normally distributed. So all that shock and awe you’ll see on the financial news today about Facebook’s massive sell-off shouldn’t be all that shocking. We dug up the following image online (not sure of the source) which lays out nicely that these types of moves happen way more than one would expect given a normally distributed data set.
And we recently delved into the understanding of these types of outlier moves by comparing Amazon’s Jeff Bezos net worth to the average to the average worker.
Mr. Bezos is the outlier of all outliers, existing so far over on the right side of the bell curve of American Net Worth readings that he’s likely a 100 sigma event, or so, as we would say in the business. Meaning he’s 100 standard deviations above the average American’s net worth with that 100 Billion to 1 number. He should literally not exist in a world which is normally distributed, being that many standard deviations above the average. But he does exist, and those $129 Billion are really his, making it painfully obvious for those of us down there within a few standard deviations of the mean that the world, especially when it comes to money and markets and everything else financial – is not normally distributed.
There have been famous blow-ups in the financial world tied to those relying on the assumption that financial markets are normally distributed, and the move from Facebook like this is a reminder that this isn’t always the case. We’re hopeful all of the artificially intelligent machines that are set to become the next crop of Wall Street and hedge fund ‘traders’ understand this better than their human counterparts. And it does seem like we’re seeing these outliers with a bit more frequency – with the VIX spike on February 5th representing 1 in a million years or so chance and Brexit a 1 in 4-million-day event. The old saying that markets take the stairs up and an elevator down has never been truer.