Fooled by randomness by Nassim

[.sigma]

I think the hardest part of buying OTM options is deciding when do I get out.

no.. timing has nothing to do with it.. that’s the whole point of buying DOTM options lol..

The hardest part is trading a negative skew strategy. Mentally most humans can’t take the consistent losses, eventually waiting for that 6 sigma move that collapses the world.

 

[VolSkewTrader]

I think the hardest part of buying OTM options is deciding when do I get out.

The hardest part of owning any option is watching them decay when the market is rangebound, and waiting impatiently for the inevitable big move that may not happen in your desired time frame. Inventoring option premium is mostly a losing strategy. Buying options is all about timing, and then getting out before the inevitable vol implosion.

 

[VolSkewTrader]

Selling "mispriced" far-out puts will eventually blow you out. The nosebleed IVs (vs the rest of the smile), juicy high skew, low prob, and nice theta income, make them really tempting to sell. But every 10 years you'll lose everything during a black swan event.

I know of a prominent large equity index prop group that is a well known premium seller, in any market environment. Since 2009 they averaged $12M+ a year trading a heavily short option position, always leaning short deltas in case of a crash. In March, they lost close to $100M over a 2 week period, as they stubbornly kept selling premium, thinking the top in vol was in. They gave away over 8 years of earnings and almost went under because they refused to adapt to a different market regime.

 

[ironchef]

The point is Volatility is usually underpriced.
Because they usually underestimate fat tails.
... The lower the probability, the less efficient.

Then, where is the risk premium the experts here kept talking about: IV > actual V, proven by numerous studies including CBOE Buy/write & PUT indices?

 

[ironchef]

Selling "mispriced" far-out puts will eventually blow you out. The nosebleed IVs (vs the rest of the smile), juicy high skew, low prob, and nice theta income, make them really tempting to sell. But every 10 years you'll lose everything during a black swan event.

I know of a prominent large equity index prop group that is a well known premium seller, in any market environment. Since 2009 they averaged $12M+ a year trading a heavily short option position, always leaning short deltas in case of a crash. In March, they lost close to $100M over a 2 week period, as they stubbornly kept selling premium, thinking the top in vol was in. They gave away over 8 years of earnings and almost went under because they refused to adapt to a different market regime.

What if I quit while I am ahead? After nine years and $12M+ a year, I retire and move to Monte Carlo?

Kidding aside, with that type of profit, perhaps one can do some deep tail hedging to avoid wipeout?

 

[JCDST1979]

no.. timing has nothing to do with it.. that’s the whole point of buying DOTM options lol..

The hardest part is trading a negative skew strategy. Mentally most humans can’t take the consistent losses, eventually waiting for that 6 sigma move that collapses the world.

I think I can do it if the bet is small enough, what I meant was when do you call your profits 5X 10X 100X?

 

[JCDST1979]

https://twitter.com/x/status/1151571849685454850

Here is an “AMA” on Reddit



Opss

I'm tempted to read those papers, but maybe I can't understand the complex math behind it.

 

[Pekelo]

no.. timing has nothing to do with it.. that’s the whole point of buying DOTM options lol..

The buying part yes you just buy it blindly. But when you cash out no, you have to time it because that is how much you are going to make. There is a huge difference between making 25%, 250% or 1000%.

If you didn't sell your now in the money puts at the bottom of this sell off, the following rally made them WORTHLESS.

So just like with pretty much everything else in trading, timing is everything.

 

[JCDST1979]

Stock market returns exhibit a more leptokurtic distribution vs a normal distribution. Leptokurtic distributions have fatter tails (higher kurtosis) which is a better representation of reality The tails, outliers, and black swans are always mispriced because most option pricing models assume a normal distribution in the returns on the underlying.

Yes but not all OTM options are mispriced the big question is: which one is too cheap? and how do you measure that?

 

[rallymode]

Kidding aside, with that type of profit, perhaps one can do some deep tail hedging to avoid wipeout?

IMO, 0 profit. You can't hedge passive short vol with anything and expect to earn. Unless you get lucky and quit while you are ahead you will eventually give it all up. Overconfidence is usually the culprit. Here are my two rules that have kept me in the short vol game for 15 years now through multiple "volmageddon" events.

1) sell vol at the trough and cut losses at the first sign of a storm, do NOT try to time the vol peak.
2) wire out annual profits, do NOT increase size and try to compound