Ever a good time to sell option premium on S&P 500?

[short&naked]

With the recent busts of LJM and optionsellers.com, I have been thinking about the feasibility of selling options without risking a blowup. Looking at LJM's performance in 2013 when vol was low appears to indicate that there are times to sell and times to buy (or at least not sell). I have set out some principles which are up for discussion and modification:

1. Only sell options on SPX or SPY when decent premium can be earned without employing a lot of leverage (i.e. not selling deep OTM options that do not pay much premium and compensating with leverage)

a) At what VIX level should one not be selling options?
b) What are the best strikes to select? (a balance between having to adjust vs. not having to over-leverage)


2. Use some of the earned inflated option premium to buy some far OTM puts (units or tennies) to hedge against a fast moving market (i.e. marking conditions where one cannot adjust / roll options positions as the market moves toward the strikes)


Hopefully some members like sle will join in.

 

[traider]

The problem with your plan is that far OTM puts have skew and you pay a lot in terms of IV to consistently hedge against the black swan crash.
There are no simple answers to what you are looking for, if you want to sell vol in a non directional way, you need a system to determine if IV is expensive or cheap.

 

[zenostiffler]

"to determine if IV is expensive or cheap"

Rather like with PER (to high? too low?) or any other facet of the markets this is not something which is ultimately determinable.

 

[traider]

"to determine if IV is expensive or cheap"

Rather like with PER (to high? too low?) or any other facet of the markets this is not something which is ultimately determinable.

Some people try to forecast future volatility using quant models.

 

[zenostiffler]

Some people try to forecast future volatility using quant models.

They do. But in the end the people who profit most are the suppliers of equipment not the traders, as in the days of the Gold Rush. Sell picks and axes and shovels don't prospect for gold?

 

[zenostiffler]

Some people try to forecast future volatility using quant models.

I think providing a product to other traders is the key. People like Simons at Renaissance have made their success out of providing liquidity and profiting from the bid offered spread. And of course it is said the HFT guys may be able to gauge what orders are out there and trade accordingly?

 

[tommcginnis]

Why short & naked?
Why only Buy Puts sometimes?

The thing about limited risk trades is that the risk is..... limited.
The thing about unlimited risk trades is that the risk is....not.

 

[Felix168]

There is a semi-mathematical explanation. Black-Scholes gives the so-called arbitrage-free pricing; a price point at which random trades will average out to break-even. By using Black-Scholes backwards, the implied volatility is calculated; the volatility that would explain the prices observed in the marked using Black-Scholes. Historically, VIX as a measure of implied volatility has been higher most of the time than the true future volatility. This can probably be explained with a slightly pessimistic view to the future. If implied volatility is higher than the future volatility, that means that an option seller is compensated more for his options, than the fair value of the risk he is taking on. In summary, premium-harvesting strategies have a statistical advantage. The nature of these strategies is to work beautifully... until they suffer from dramatic drawdowns. This can be mitigated by diversification in time and across markets, and by having a better volatility model. Ultimately, volatility is mean-reverting, so there is a good chance that in times where volatility is high above average, options can be sold successfully.

Cheers, Felix

 

[zenostiffler]

There is a semi-mathematical explanation. Black-Scholes gives the so-called arbitrage-free pricing
Cheers, Felix

Unfortunately as we know Black Scholes assumes stock returns are normally distributed, which they are not.

It's an art not a science. All of it. If we live in a deterministic universe maybe precision will be possible eventually, using AI. However even if this proves to be the case we know that complex systems can not be predicted, even when they are deterministic.

Thus....none of this is "predicable" per se. Even though volatility is mean reverting it is pretty difficult to devise a system to sell and buy volatility at given triggers.

I have done a great deal of empirical investigation using both Vix options and futures. At the end of it the only convincing strategy was to buy, hold and roll Vix puts at or near the money.

Or indeed sell longer dated volatility futures and wait until contango brings the far out contract back to the lower spot value.

And yes, to a certain extent one can take protection with calls....but....In particular very long dated Vix calls, further out of the money, and rolled monthly.

"The nature of these strategies is to work beautifully... until they suffer from dramatic drawdowns. "

Yes, pretty hard to mitigate this especially since systematic strategies have big problems with the almost instantaneous swings in the Vix.

In any event, all my back testing code can be found here: Gist.

In particular I worked hard and long on various spreads and strangles on Vix options. I traded XIV successfully for a year or so and happily had protected myself with long dated puts on a rival fund so came out well when the s**t hit the fan.

 

[REDP1800]

Unfortunately as we know Black Scholes assumes stock returns are normally distributed, which they are not.

It's an art not a science. All of it. If we live in a deterministic universe maybe precision will be possible eventually, using AI. However even if this proves to be the case we know that complex systems can not be predicted, even when they are deterministic.

Thus....none of this is "predicable" per se. Even though volatility is mean reverting it is pretty difficult to devise a system to sell and buy volatility at given triggers.

I have done a great deal of empirical investigation using both Vix options and futures. At the end of it the only convincing strategy was to buy, hold and roll Vix puts at or near the money.

Or indeed sell longer dated volatility futures and wait until contango brings the far out contract back to the lower spot value.

And yes, to a certain extent one can take protection with calls....but....In particular very long dated Vix calls, further out of the money, and rolled monthly.

"The nature of these strategies is to work beautifully... until they suffer from dramatic drawdowns. "

Yes, pretty hard to mitigate this especially since systematic strategies have big problems with the almost instantaneous swings in the Vix.

In any event, all my back testing code can be found here: Gist.

In particular I worked hard and long on various spreads and strangles on Vix options. I traded XIV successfully for a year or so and happily had protected myself with long dated puts on a rival fund so came out well when the s**t hit the fan.

ONLY IF YOU ARE PUTTTING ON A SPREAD!!!!!!!!!!!!!!!!!!!