Credit Put Spread.. ATM vs OTM

[Herkfsu]

Hi all. I am curious the thoughts of the board on the logic behind perpetually selling credit put spreads atm vs otm. I see research citing IV is overstated by 3 vol points compared to realized vol. See the link below.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2579232

This is why option sellers overtime beat option buyers. Everyone knows this. My question though is how to best exploit this. I understand there is skew and selling a spread at higher vol is better than lower vol, given identical underlyer, so this possible favors otm. But since vega peaks atm, wouldn't it be best to "take" these 3 points with vega at it highest possible value? It would lead me to believe selling put spreads atm would be more profitable than selling them 5 or 10% otm.

Any thoughts on the matter are greatly appreciated!

*I am not saying this is a great strategy, especially with low vol, but I am more interested in the theory on how markets work.

 

[CBC]

This is why option sellers overtime beat option buyers. Everyone knows this.

U sound confused, I'm comming under the impressions that you think option buyers are always buying when IV is outta whack with historical.

To back this statemet up, why don't you show us that IV has incorrectly guessed the market plus there were always option buyers buying when IV was higher.

 

[Herkfsu]

U sound confused, I'm comming under the impressions that you think option buyers are always buying when IV is outta whack with historical.

To back this statemet up, why don't you show us that IV has incorrectly guessed the market plus there were always option buyers buying when IV was higher.

Sorry, I don't completely follow. I was just stating it is known that in the long run HV has been shown to be lower than IV. I never said HV couldn't be greater than IV.

 

[newwurldmn]

Hi all. I am curious the thoughts of the board on the logic behind perpetually selling credit put spreads atm vs otm. I see research citing IV is overstated by 3 vol points compared to realized vol. See the link below.

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2579232

This is why option sellers overtime beat option buyers. Everyone knows this. My question though is how to best exploit this. I understand there is skew and selling a spread at higher vol is better than lower vol, given identical underlyer, so this possible favors otm. But since vega peaks atm, wouldn't it be best to "take" these 3 points with vega at it highest possible value? It would lead me to believe selling put spreads atm would be more profitable than selling them 5 or 10% otm.

Any thoughts on the matter are greatly appreciated!

*I am not saying this is a great strategy, especially with low vol, but I am more interested in the theory on how markets work.

Good question.

One isn't strictly better than the other.

Typically credit spread sellers are taking a terminal distribution view and prefer the higher probability of earning vs the higher return. Also they are offsetting lower vol exposure against higher vol level. Which is more important, is the key question.

If you are dynamically hedging then you are more sensitive to the actual realized vol and you have some sentivity to the path dependency. This can make the otm options more or less profitable than the ATM.

 

[CBC]

Sorry, I don't completely follow.

You said that option sellers beat buyers over time, which I quoted.

I said that you are confused because take supertrader karen for example, she is / was the biggest option seller known. Now she blew her account / is under investigation by the SEC for fraud. Probably never trade again.

I honestly don't understand what you mean.

You said that IV was higher by 3 points, which I'm presuming you meant on average over time because IV doesn't sit 3 points above historical every second of every day.... which is my point... you're comming under the assumption that buyers are always placing trades which simply isn't the case.

Reply if you still don't understand.

 

[Herkfsu]

Good question.

One isn't strictly better than the other.

Typically credit spread sellers are taking a terminal distribution view and prefer the higher probability of earning vs the higher return. Also they are offsetting lower vol exposure against higher vol level. Which is more important, is the key question.

If you are dynamically hedging then you are more sensitive to the actual realized vol and you have some sentivity to the path dependency. This can make the otm options more or less profitable than the ATM.

Thanks for the reply.

I understand the idea and logic behind delta hedging, but I am not sophisticated enough to do that.

My thought was that underlying movement will net out to 0 over the long term and vol risk premium would be the only constant. If it is true option sellers are selling at 3 vol point higher on average on every trade, why wouldn't the logic follow that I want those 3 vol point to be at peak vega?

 

[Herkfsu]

You said that option sellers beat buyers over time, which I quoted.

I said that you are confused because take supertrader karen for example, she is / was the biggest option seller known. Now she blew her account / is under investigation by the SEC for fraud. Probably never trade again.

I honestly don't understand what you mean.

You said that IV was higher by 3 points, which I'm presuming you meant on average over time because IV doesn't sit 3 points above historical every second of every day.... which is my point... you're comming under the assumption that buyers are always placing trades which simply isn't the case.

Reply if you still don't understand.

Thanks for the reply.

Do you not agree that option sellers as a whole beat option buyers? Just like a local insurance company in Louisiana can go bankrupt during hurricane Katrina(Karen), it doesn't mean selling insurance is a bad business.

I certainly understand that a put buyer could by at an IV of 15 and RV turns out to be 20, 30 or even 50. But over the long run, the research I posed shows it will be around 12.

I want to understand how to best capture these 3 vol points.

 

[newwurldmn]

Thanks for the reply.

I understand the idea and logic behind delta hedging, but I am not sophisticated enough to do that.

My thought was that underlying movement will net out to 0 over the long term and vol risk premium would be the only constant. If it is true option sellers are selling at 3 vol point higher on average on every trade, why wouldn't the logic follow that I want those 3 vol point to be at peak vega?

Basically the OTM seller is sacrificing some pnl for a higher probability of making money.

 

[Herkfsu]

Basically the OTM seller is sacrificing some pnl for a higher probability of making money.

I understand that the OTM sellers will win more often, but if OTM sellers win $11 while risking $100, 9 out of 10 times, will ATM sellers win $60 while risking $100 1 out of 2 times?

(obviously over simplified)

 

[newwurldmn]

I understand that the OTM sellers will win more often, but if OTM sellers win $11 while risking $100, 9 out of 10 times, will ATM sellers win $60 while risking $100 1 out of 2 times?

(obviously over simplified)

It might be 11.10 in your analogy because the otm seller will be selling a higher vol (skew).

As you said it's over simplified because the reality is that that skew isn't free money.