Fooled by randomness by Nassim

[Magic]

Near the bottom on a 10-year chart? It's not an absolute number but a significant divergence between implieds and stat what you want. The market feels dead and all the pundits on TV are telling you to hedge because of how cheap the vix is. That's when you should be selling vol.

I'd say 2-3SD is a good place to put your stops but obv that's very model dependent.

Hi rally,

Do you trade VIX futures almost exclusively to express your views on index vol and especially to short it? Or do you trade SPX options as well?

Wondering if there is a difference between the two in overall edge to be captured or in capital intensivity.

 

[ironchef]

Have a look at the attached file for example calculations. Of course they are wrong because it assumes a normal distribution and no skew or kurtosis, but you get the basics.

If that is what you professionals do, we mom and pop amateur retails don't have to worry about you eating our lunch.

 

[.sigma]

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.

timing comes from order entry.. even for DOTM options. You can’t just blindly buy them, as you’ll bleed continuously. There’s a way these guys finance these options via short premium as well so it’s not solely long DOTM strikes.

But at the same time I’ve never traded this way and most likely never will, but understanding the characteristics is interesting

 

[.sigma]

Can you give me an example?

Figure out how far away from the money a 6 sigma move will occur +/- then buy the according strikes

 

[luckyfnlou]

I bet Taleb just does put ratio backspreads. Seems hard to believe he just buys otm puts with his giant brain. But what do I know.

 

[Sig]

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.

While models might assume a normal distribution, it would seem no-one uses those models to actually price options because the prices don't follow a normal distribution model do they?

 

[VolSkewTrader]

While models might assume a normal distribution, it would seem no-one uses those models to actually price options because the prices don't follow a normal distribution model do they?

The continuously compounded daily returns of a stock or equity index are generally accepted to be normally distributed, which is a common assumption in most option pricing models. While the price of a stock or index is lognormally distributed since its price cannot go below zero.

Often times (as we saw March and early April) stock market returns displayed a leptokurtic distribution with fatter tails and more data points with 3+ standard deviation moves. However, everyone still quotes, prices, and hedges options from pricing models that use normally distributed returns in the underlying.

 

[Sig]

The continuously compounded daily returns of a stock or equity index are generally accepted to be normally distributed, which is a common assumption in most option pricing models. While the price of a stock or index is lognormally distributed since its price cannot go below zero.

Often times (as we saw March and early April) stock market returns displayed a leptokurtic distribution with fatter tails and more data points with 3+ standard deviation moves. However, everyone still quotes, prices, and hedges options from pricing models that use normally distributed returns in the underlying.

If that is the case then why do we see skew/volatility smile in options prices?

 

[VolSkewTrader]

According to Professor Taleb, the downside put skew is not steep enough. Or maybe the vol smile should be less linear and more convex, more parabolic on the far-out put wings.

 

[panzerman]

I bet Taleb just does put ratio backspreads. Seems hard to believe he just buys otm puts with his giant brain. But what do I know.

One strategy he has talked about in the past was to buy T-bills, and use the interest income to purchase OTM options. That is an example of his barbell strategy, in other words take low risk and enormous risk at the same time. I do not know what strategies he uses currently.