I doubt that... fat tails will be priced in the moment it gets heavily traded...
How Profitable Is Writing Options
- Thread starter ironchef
- Start date
I doubt that... fat tails will be priced in the moment it gets heavily traded...
JackRab & Stymie,
Both your comments are very helpful.
So a high Kurtosis means the IV for OTM and ITM are generally higher than ATM. i.e., the market (or marker makers) believes a fat tail is likely and price that in by jacking up the IV/premium at the tails. Whether I can profit from it depends on my view of the tails. If I think they are higher than what was priced in I can go long and win; if I think they are lower I can go short and win?
Give me a new way to look at long/short instead of just blindly go one way or the other. However, that means I still need an opinion of the market to make a profit.
Best wishes.
Both your comments are very helpful.
So a high Kurtosis means the IV for OTM and ITM are generally higher than ATM. i.e., the market (or marker makers) believes a fat tail is likely and price that in by jacking up the IV/premium at the tails. Whether I can profit from it depends on my view of the tails. If I think they are higher than what was priced in I can go long and win; if I think they are lower I can go short and win?
Give me a new way to look at long/short instead of just blindly go one way or the other. However, that means I still need an opinion of the market to make a profit.
Best wishes.
@ironchef, you almost always need some sort of opinion of the market when trading. In trading options, you will be making assumptions on the volatility and direction.
With options, you should start thinking the market prices everything correctly (which it never really does). Then think about why the IV is at a certain level. Why is it priced higher than Historical Vols? Why is it lower than Index IV? Why is there a high skewness? What's coming up in the next few months? What's the IV of competitors and why could it be different.
That's your start, then you can think about whether it should be different....
And also, close to expiry IV doesn't really mean anything anymore. In the last week (or two) you should start looking at the straddle value. A $2 straddle with a week to go on a stock of $100 can be a good buy if you expect some daily move of $2...
With options, you should start thinking the market prices everything correctly (which it never really does). Then think about why the IV is at a certain level. Why is it priced higher than Historical Vols? Why is it lower than Index IV? Why is there a high skewness? What's coming up in the next few months? What's the IV of competitors and why could it be different.
That's your start, then you can think about whether it should be different....
And also, close to expiry IV doesn't really mean anything anymore. In the last week (or two) you should start looking at the straddle value. A $2 straddle with a week to go on a stock of $100 can be a good buy if you expect some daily move of $2...
I would add to JackRab's insightful comments. The next step is to think about your risk return payoff. What do you expect from the market and what returns would that give you in the time frame your options offer. There needs to be a higher return relative to the risk weighed against your expected success rate. Many traders get this part wrong because they cant properly assess the risk of the tail events and the so called "Black Swans". To be successful, your wins need to be multiples of your losses unless your probability of success is greater than say 60% but again none of your losses can be more than 2x your wins to breakeven over time after commissions. If you can setup the plan to succeed and make money, then you need to be able to create enough occurrences so the probabilities play out as they should which means thousands of trades which is both time and transaction costs.
To enhance returns, specially when it comes to seasonality. The summer is usually slow and sideways, so writing calls (or even puts too) gives you a few extra %. The autumn is usually very bearish so if you are not in cash, writing deeper ITM calls protects you more.
the problem with that scenario is that the market factors that in and the premiums are also little as the volatility dies down. then what happens is you get a one day spike and you're immediately on margin call. the only time to EVER sell options is when the market is spiking. to make money selling options you have to EMBRACE the risk that others fear. it could be said that fear equates to profits.
low volatility equates to low profits and high risk when writing options.