Every put you’ve ever bought was priced off a model that thinks stocks go up.

I’m not criticizing the model here. That’s what the thing assumes, and it has been wrong in one particular way since 1973.

Traders have known this for decades and they correct for it, which is why your downside protection always feels like it costs more than the math says it should. It does cost more, and somebody decided that on purpose.

Once you understand exactly where that extra money is going and who is collecting it, you stop buying puts the way most people buy them, and you start doing something else entirely.

Below is the whole thing, plus what I do instead.

Let me ask you something, and there’s a gold star in it if you get it right.

The Black-Scholes model. Is it biased to the upside for stocks, or is it biased to the downside?

Upside. It assumes stock prices are lognormally distributed, which is a fancy way of saying the model expects them to drift higher over time and treats an enormous crash as something close to impossible.

Now, that’s a reasonable assumption most of the time. If stocks aren’t going down, what are they doing? They’re going up, okay, and the model is built around exactly that.

The problem is what happens on the days it’s wrong.

What Happened On A Monday In 1987

Before October 19th of that year, implied volatility across strikes was more or less flat. A put and a call the same distance from the money cost about the same thing, because everybody trusted the model.

Then the S&P fell more than 20% in a single session.

Under the model’s own assumptions that move was roughly a 20-standard-deviation event, which is not unlikely so much as functionally impossible. It happened anyway.

And every market maker on earth learned the same lesson on the same afternoon, which is that the left tail is a lot fatter than the math says it is.

They never forgot it. What they did instead was start charging for it.

What Traders Do About It

They jack up the price of puts, and that’s the entire correction.

The model spits out a number, the trader looks at that number for a downside strike, and says no thanks, I’m charging more than that. So out-of-the-money puts carry higher implied volatility than at-the-money options, and at-the-money carries more than out-of-the-money calls.

That’s your volatility skew, and it has been sitting there permanently since 1987.

So when you go to buy a put you’re paying the model price plus almost forty years of institutional memory about one terrible Monday.

Now Look At What That Costs You

Pull up a chart of SPY for the last six months and ask yourself an honest question.

How much money would you have wanted to spend buying puts or put spreads over that stretch, and besides that one blip in April, how much of it would you have gotten back?

Not much. Because most of the time the market does the thing the model assumes it does, and you sat there paying a premium for a crash that didn’t arrive.

I want to be careful how I say this, because I’m not telling you to be naked long and hope, and protection absolutely has a place. What I’m telling you is that buying it outright, month after month, means paying the skew every single time, and the skew is not on your side.

So What Do I Do Instead

I collect it.

The structure I use has a put spread in it, but I want the market paying for that spread instead of funding it out of pocket myself. You do that by selling something against it, and the something you sell carries the same inflated volatility you’d otherwise be handing over.

The point of the whole exercise is that I don’t have to know which direction this market goes. I want to be positioned for a move either way and get paid for the waiting, and then close the pieces when they start paying me.

Which is how a hedge fund thinks about it. Less about what’s going to happen, more about who’s overpaying for what, and whether I can get on the other side of it.

Could I be wrong on any given trade? Absolutely, and I have been plenty of times. But the skew doesn’t care what I think, and it has been sitting there since 1987.

Andrew Giovinazzi