Condor Credit Spreads: Most common misconceptions, mistakes, lessons

[newguy05]

Quote from stoic:

What I'm saying is that the Greeks are base on a theoretical model and thus have little if anything to do with the real world.

1) I dont know how to make it any clearer, my point was looking at 1 set of greeks(per underlying) for your positions is much easier and straightforward to manage then trying to figure out the various combos in your account. Whatever you are saying about greeks and theoretic model has no relevance to my statement.

2) Now about your unrelated discussion - greeks are based off theoretical and therefore nothing to do with real world. I think that's nonsense. With the exception of maybe how IV is calculated, all the other greeks - delta/gamma/theta etc.. that are displayed by the brokers software are mostly accurate and they are all important in option trading (seriously? we are discussing this?) Like jwcapital, it's what I use as well, it gives me a real time snapshot of my option positions and how they will behave when price/iv/date changes - allow me to make decisions based off my predictions

 

[HowardCohodas]

Quote from rosy2:

condors and flys dont really start paying off until closer to expiration

I know my experience is limited (5 months paper, 3 months money) but this is just not my experience so far. If the market moves sufficiently, one side of the IC has in several cases yielded 80% to 90% of its potential yield which permits me to roll that side to a closer spread and increase my yield for that month's spreads. Rolling does not increase my margin requirements. In at least one case, I was able to roll twice and profit from all three credit spreads on that side and once on the other side. The side not rolled was a nail biter, however.

It should be noted that I usually enter at least one side of an IC as early as 60 days before expiration. This frequently gives me some additional credit as well as some additional time to use my rolling strategy.

 

[HowardCohodas]

Quote from stoic:

What I'm saying is that the Greeks are base on a theoretical model and thus have little if anything to do with the real world.

The Black-Scholes paper "The Pricing of Options and Corporate Liabilities" was published in 1973. The key insight was that if a stock was traded, the option price could be determined with a high degree of accuracy. Scholes won a Nobel Prize in economics for his work. Black was not eligible because he was then deceased when the prize was awarded.

While the model yields results that are approximate because determining some the parameters of the model in imprecise, it is "close enough for practical purposes." That's "real world" enough for me.

 

[rew]

Quote from stoic:

What I'm saying is that the Greeks are base on a theoretical model and thus have little if anything to do with the real world.

That depends on how accurate your theoretical model is. There are pricing models that allow for non-zero skew and kurtosis. There are pricing models based on variable volatility. There are pricing models based on the underlying having GARCH(1, 1) price statistics. For each of these delta is the derivative of the option price w.r.t. the underlying price, gamma is the second derivative, theta is the derivative of the option price w.r.t. time, etc. *How* they are calculated varies with the option pricing model.

Every day delta hedgers and market makers use those "theoretical models" and make money while the gamblers try to guess whether a stock will go up or down.

 

[stoic]

Quote from rew:

Every day delta hedgers and market makers use those "theoretical models" and make money while the gamblers try to guess whether a stock will go up or down.

Every day the market makers make money on the spread.

 

[newguy05]

Quote from stoic:

Every day the market makers make money on the spread.

and what do you think the mm use to hedge their open positions?

I mean it cant be the useless greeks based on "theoretical models" that has nothing to do with the real world......

 

[jwcapital]

Here is a practice problem with IC's vs IB's. I am looking at the October 2010 Futures options with the DEC 2010 as the underlying. When I place IC's I like to place the body at 1 SD (standard deviation). So, this month the ATM strike for me was 1115. The short put would be placed at 1045 and the short call at 1185. Here is the problem. The short put's premium was 7.00 and the short call's premium was 2. Given this scenario, where do you place the wings? The short call's premium is ridiculously low. By placing any wing the net premium isn't even worth the risk. Plus the margin requirement is 2 1/2 times higher than the equivalent IB. So, how do we make this a better trade?

 

[stoic]

Quote from newguy05:

and what do you think the mm use to hedge their open positions?

I mean it cant be the useless greeks based on "theoretical models" that has nothing to do with the real world......

Your right...it can't be.

 

[syswizard]

Quote from stevenpaul:


I don't know, maybe traders think the word iron means they can't lose as much money. I know if I were putting my money on something as fragile and ephemeral as a butterfly, I'd want it to be made of iron too. Unfortunately, the reality is that one is no more ironclad than the other.

This is all so clearly evident when reviewing the performance of hedge funds on hedgefund.net. Those funds employing these strategies show fairly consistent positive results from month-to-month...but then you'll see these horrific 1 month performances. You know they got "blasted" that month with a sharp move in the market.
It's the old "Vic Niederhoffer" effect. I would say bet sizing and risk management are paramount for this strategy over the long term.

 

[rew]

Quote from stoic:

Your right...it can't be.

I'm sure you'll find that every market maker knows the greeks for his option book. And I'm sure it's not just an intellectual interest. And yes, he gets the greeks from theoretical models, although they may be proprietary and not generally known.