An Edge?
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For the seller to have an edge, you also have to believe that the market consistently misprices options.
For an option that has a B/A of 2.95/3.05, the expected value of this option as determined by the market is 3.00. Neither the seller nor the buyer has an inherent edge.
Only when you use some sort of method/data that can help you select and/or manage your options whether they be bought/sold/spread etc to produce results where you collect more in total on your winners than you lose in total on your losers does one make money with options in the "long" run.
Joe.
I think if you had no other information, you could sell a out of the money put and call.
The following will usually happen:
1) Both expire worthless, you get to keep the money.
2) The market trends strongly to one side, and you are now underwater on that position.
a) You have stop loss mental or actual where you kill the side of the trade that is costing you money, and keep the winning trade.
b) This trade was only a small position of your portfolio, and you decide to take the loss at expiration.
c) You hedge the risk by either buying a lower priced call or put, or for example shorting or buying the stock or index at market price, or by buying or selling futures.
Now, if you can with a higher probability predict market direction, then for example, you think the market will go up or be flat, you would sell a put, if you determine market will go down, sell a call. Also, you could hedge the risk at the start by just selling a vertical instead of taking a full position.
Or if you really think you may have an edge like I believe I do, just place a directional bet each day using futures and make money most days instead of waiting for the option to expire.
The following will usually happen:
1) Both expire worthless, you get to keep the money.
2) The market trends strongly to one side, and you are now underwater on that position.
a) You have stop loss mental or actual where you kill the side of the trade that is costing you money, and keep the winning trade.
b) This trade was only a small position of your portfolio, and you decide to take the loss at expiration.
c) You hedge the risk by either buying a lower priced call or put, or for example shorting or buying the stock or index at market price, or by buying or selling futures.
Now, if you can with a higher probability predict market direction, then for example, you think the market will go up or be flat, you would sell a put, if you determine market will go down, sell a call. Also, you could hedge the risk at the start by just selling a vertical instead of taking a full position.
Or if you really think you may have an edge like I believe I do, just place a directional bet each day using futures and make money most days instead of waiting for the option to expire.
That is correct (but only for the market as whole, not for individual stocks). I believe that implied volatility behavior across strikes and times is self-inconsistent, and it would favor the seller of ITM calls.
why?
There is no edge if you're just blindly selling vol for the sake of selling it. All you're doing is writing insurance contracts, so the expert is confusing potentially making some money due to taking on risk and getting a premium for doing as much with an edge.
In a sense no different than someone selling car insurance. In the short term you can make some money selling car insurance by collecting premium from a lot of shitty drivers (and in a sense your expert is confusing that with an edge) but if you don't collect sufficient premium relative to the shittiness of the drivers then you're probably going to lose some serious money over the long term.
Same when selling vol, you will potentially get paid in the short term for assuming risk from someone else but over the long term if you aren't properly managing the risks you're assuming then you'll probably end up blowing up.
So the edge from being net short vol would come from how you manage the risk when selling vol. And that would come down to your option pricing model or some strategy around playing around with the vol curve.
In a sense no different than someone selling car insurance. In the short term you can make some money selling car insurance by collecting premium from a lot of shitty drivers (and in a sense your expert is confusing that with an edge) but if you don't collect sufficient premium relative to the shittiness of the drivers then you're probably going to lose some serious money over the long term.
Same when selling vol, you will potentially get paid in the short term for assuming risk from someone else but over the long term if you aren't properly managing the risks you're assuming then you'll probably end up blowing up.
So the edge from being net short vol would come from how you manage the risk when selling vol. And that would come down to your option pricing model or some strategy around playing around with the vol curve.