How Profitable Is Writing Options

[vanzandt]

What happened on Nov 7?

O wait... just one of the most significant moments of 2016...

Don't just write options based on IV>HV. Think about market sentiment and what's on schedule. BREXIT, US elections... not really moments to sell naked options.

On market efficiency..., there are people stating selling is always better than buying.... maybe so in the long run, but how big are you trading? When you're leveraged up the hill, you're just a sitting duck. Eventually you will get hit.

Like @Pekelo mentioned, the Marsman dude got f^$@ed royally because he used max leverage selling OTM, which eventually turned sour.... not that we didn't warn him.

Marsman got a sponsor and is allegedly up 87K U.S..... just so ya know.

I saw the the paperwork, and unless he is a master of photoshop.... the dude is kicking ass. That being said, anyone can certainly master photoshop, I dated a photographer for a long time. . But why? Whatever it is he's figured out... it works. Until it doesn't I guess. He won't share though. Pisses me off fwiw.

 

[ironchef]

Don't just write options based on IV>HV. Think about market sentiment and what's on schedule. BREXIT, US elections... not really moments to sell naked options.

Yes thanks.

 

[JackRab]

Marsman got a sponsor and is allegedly up 87K U.S..... just so ya know.

I saw the the paperwork, and unless he is a master of photoshop.... the dude is kicking ass. That being said, anyone can certainly master photoshop, I dated a photographer for a long time. . But why? Whatever it is he's figured out... it works. Until it doesn't I guess. He won't share though. Pisses me off fwiw.

Exactly, untill it doesn't... you do know how he busted right? I forgot which biotech it was, but he was short OTM puts and it collapsed 90% I think... You can argue, wel how many times does something like that happen???... (as he did)... but it will happen... and he will bust again...

And what he thinks is the holy grail... the costless/riskless collar... doesn't exits. Can't be traded as a strategy in one trade, so not do-able without risk... that site he refers to has it wrong, the numbers do not match up and will never match up.

So in short, it doesn't work in the long run.

 

[Stymie]

I am posting this thread not to argue a position but to seek help.

I used to mechanically wrote call options to capture time decay and collect "insurance" premium (after watching videos online and reading books). Then I thought I could profit from selling call options when volatility was high compared to HV. Neither worked for me.

This chart captured some fallacies of my thinking then that selling options had an edge. If I sold options when IV was at 26.7%, much higher than HV, on Nov 7, I would have lost a ton, especially if I sold OTM and used margins.

I think the market is quite efficient so neither buying nor selling blindly has advantage. One needs knowledge and judgement to make money in trading options. I am still looking for my knowledge and judgement for writing winning options.

Comments are welcome especially if you think I am wrong or can point me to a better understanding. By the way for the period of the chart HV and IV averaged out to be about equal.

Cheers and happy Thanksgiving.

View attachment 168303

The problem is that the implied vols have come down significantly from the 1980's as books proclaiming that selling premium is the way to make a living have propagated and a huge number of people have used the strategy from their homes and personal devices. There are three main issues which will prevent you from winning with that strategy:

1. US stock market makers - between liquidity providers paying $1.50 per option to see your flow before going to the floor and the disparate option markets being manipulated by computers watching order flow, you have no chance in getting proper fills.

2. Commissions on options are variable based on the number of options where stocks are fixed and as a result you will pay too much in transaction fees. They will also charge $15 dollars for exercising each option strike which is an automated activity done by the exchange and not the broker.

3. Option markets are efficient and self fulfilling as high vols imply that there are big bets being placed on a binary outcome and they will then unwind after said event. This liquidation will cause wild swings in the underlying as a result. The liquidity is found in the underlying and not the options so the whales use the more liquid stock to exit creating imbalances.

The big winners are: brokers, liquidity providers, market makers and the executive boards of the public companies that pay themselves free call options in their own stock.

The only strategy that makes sense if your not a broker is to identify a company with great prospects and a profitable approach with little competition and buy their stock on a scaling basis. If you want to try to get creative, sell straddles against this stock and use the underling market to unwind the trade. This will lock in profits and allow you to own more stock if it goes down. You will have to look at the total premium collected from the straddle and accept the maximum profit it would allow over said time frame. If the amount is too small which is normally the case, then you dont want to sell the straddle. Remember that stocks have higher kurtosis today then the implied volatility suggest so you will miss out on the big moves up if you put on the straddle against the underlying stock. Define your profit goal which is 4x your acceptable loss or more and be mechanical in your approach. Good Luck on your journey!

 

[invest2bfree]

You are assuming that somebody wants to be in the market.

I just don't want to hold anything, this is why I do weekly options, sell Monday or Tuesday and be out by Friday.

I approach this more like a bond trading, if I can get anywhere between 3-10% return with very less risk to my capital I am fine.

 

[ironchef]

And what he thinks is the holy grail... the costless/riskless collar... doesn't exits. Can't be traded as a strategy in one trade, so not do-able without risk...

Can you kindly explain. I was told when my calls became profitable, I could buy a collar around the calls to preserve profits.

I assumed you were not referred to that type of collar trade but one where short/long an option and bought a costless collar around the trade all done at the same time? Why doesn't that work?

 

[ironchef]

Remember that stocks have higher kurtosis today then the implied volatility suggest so you will miss out on the big moves up if you put on the straddle against the underlying stock. Define your profit goal which is 4x your acceptable loss or more and be mechanical in your approach. Good Luck on your journey!

Thank you. I really appreciate all the folks here giving me useful comments. Your views is greatly appreciated.

I have a specific question: Is kurtosis the technical term for "fat tail"? The equities I trade seemed to make big moves more frequent than lognormal. That means they have high kurtosis?

Regards,

 

[JackRab]

@ironchef, yeah I should rephrase... A costless collar can be traded of course... but they always have risk. A collar with no risk is impossible.

I think Marsman was referring to this: http://www.theoptionsguide.com/costless-collar.aspx

The example on this website is a total load of crap. In the example, the writer is long stock currently trading at $50 and want to protect this with a long July-50 put at $5 and simultaneously sell the July-60 call at $5. This way, he's totally covered below $50 and makes a profit up to $60.

But this is impossible... those prices are a total brain-fart.

If the July-50 put is trading at 5, due to put/call parity the July-50 call should be trading at $5. Or close to it, depending on the interest rate etc.... But in no-way the July-60 call will be close to 5...

So... his idea is not going to work without risk. You can lower risk, by doing credit spread instead of outright short strangles.... but you won't make the %'s he's claiming...
Remember, no risk no glory... the profits he claims are totally achievable, but you run large risks. Risks he isn't willing to see...

In your case, when your calls become profitable (or stocks), you can trade a collar (or risk reversal, that's how I used to call it) but you would've already had the risk associated with being long with the initial trade.... so again, no riskless system...

 

[JackRab]

Thank you. I really appreciate all the folks here giving me useful comments. Your views is greatly appreciated.

I have a specific question: Is kurtosis the technical term for "fat tail"? The equities I trade seemed to make big moves more frequent than lognormal. That means they have high kurtosis?

Regards,

Uhm, yeah I think so. Both for calls and puts. More kurtosis would mean the OTM calls and puts have a way higher implied volatility. That's actually quite normal, especially for OTM puts (skewness).

Index options normally only have a certain skew, where OTM puts have a higher IV and OTM calls a lower IV than the ATM.
In stocks it depends. Sometimes the ATM has the lowest IV, so more kurtosis. Sometimes it's the same as with index options. Sometimes the OTM calls have a higher IV and the OTM puts a lower IV, which makes sense in takeover/bidding war situations.

EDIT....

I had to look it up, a high kurtosis (>3) means a leptokurtic distribution and a low kurtosis (<3) is a platykurtic distribution, 3 is normal.

Come to think of it... if you would expect big moves, you would want to be long the straddle and short OTM strangle. If that's the going trade, it would push ATM vol up and OTM down... that's quite normal just before earnings release.

In your case, it might mean the opposite, because the market is not expecting a move on a specific date, so... relatively low ATM vol compared to OTM's. So that would mean platykurtic/low kurtosis?

EDIT 2...

But then again, if I look at other kurtosis explanations... it seems Leptokurtic distributions have additional variation in the tails meaning fat tails...

It's a bit tit for tat I think... food for analysts and quants. I just trade expensive vs cheap....

 

[Stymie]

Yes - High Kurtosis means fat tails. OTM options may be too cheap relative if you think fat tails will happen. Fat tails disrupt all option pricing as risk is undefinable although people try with normal distribution curve. This is the rare time where you want to buy options.