Is it possible to make >=20% expected geometric mean returns per year with options? Why?

[OptionGuru]

Options are generally used by business insiders, the probability of corporate insiders profiting is determined based on their inside knowledge not just technical execution.

I doubt it ....... You never know how the stock will react to news. Most "inside knowledge" would be worthless.

You're a poker player? Great. Then imagine sitting at the table where the house has a big edge, there's a huge vig you'll pay on every bet, and there's a stop watch running on every hand that turns out the lights when the time is up.

Welcome to the options market.

IMO ....... The poker/option analogy has no place in the Options forums on ET. Chit Chat would be the forum for a poker discussion.

 

[Timetwister]

Forgive the excessive length. I only post here once in a blue moon these days so there's a lot of thoughts to get out when the mood strikes.

If I were to give someone advice who is just starting out studying the market, regardless of the instrument or type of security, it would be to begin studying and developing an understanding of underlying market behavior and movement, however, that's just me.

There are a variety of ways to succeed in this industry. I'm sure there are some individuals who grind out a large volume of razor thin +EV trades using statistics, or are capitalizing on intelligently captured premium, or boost their returns with superior hedging techniques, etc.

I've seemed to come across four types of mindsets about the market in environments like this. Sometimes they overlap slightly;

1. Participants using a bland yet tried and true strategy; like buy and hold with a diversified portfolio. The market interests them and they like to talk about it or study, but they don't do anything more complicated than that for a myriad of reasons.

2. Participants who develop an intelligent understanding of the conventional market practices like above, and seek to optimize them to enhance their returns. Seems like you've done or started to do this with value investing vs. just holding an index, for example. Other low-hanging fruit to enhance returns without much complexity or advanced study is the strategic use of very slight leverage to increase returns over time while still keeping a near 0% risk of ruin using basic past market statistics, or basic hedging techniques using long-term options in certain ways to slightly elevate the r:r over time of a portfolio.

3. Traders and individuals that design and also have the mental capacity to execute much more precise systems that tightly control risk and exploit environments that provide very favorable returns to those controlled risks. The more precision a system has, and the more consistency a user of such is able to operate with, higher leverage can be used as well to greatly enhance returns.

3b. A mass of individuals who think this is possible, and are either slowly building the skills needed to operate this way, or far more likely are just spinning their wheels trying to attain something they don't have one or many of the tools required to do so (mental organization, emotional control, free from delusions, etc.)

4. Cynics at varying levels of pessimism. Either due to their personal experiences or set of beliefs about the market, they usually heavily doubt, flat-out disbelieve, and are even hostile toward the idea of #3, even though there is plenty of evidence lying around that a small group of people are able to do things like this consistently. May even doubt any optimization over the broad-based market is possible or something [which is absurd to me].

You've got to decide which bucket you want to put yourself into before you go any further. How much of your time and vitality are you willing to pour into the market. Are you going to be able to stay optimistic and motivated despite set-backs? Can you approach this in an intellectual manner or are you going to be driven by your emotions? Are you patient enough to properly equip yourself with everything you need to interact successfully with the market at a given level before you attempt to do so?

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Anyway, to try to get back to the topic at hand, I think you've started in the right place. Investigating whether something is possible before commiting yourself to it. The answer to your question is yes, 20% per year can easily be achieved over a long period of time, and even blown out of the water significantly.

If you need convincing of that fact, just think back to your experiences at poker. You should have a massive amount of experience with the fact that humans fail very often at being rational. A man, even who knows how to play poker quite well, might play a sub-par hand in a poor position simply because he lost control of his emotions.

Others might content themselves with learning just enough about the game to be entertained and bleed slow losses over time, but they don't care. Good players with a good game might get impatient for money and take excessive risks because of it. They might even make perfect decisions and still get blown out by playing far above responsible stakes for their bankroll.

The market is no different. People don't always buy and sell where reason dictates. The greater amount of emotion there is in the market; the greater opportunity there is for those who can capitalize on it. There are some killer strategies that can be designed that will take a position a couple times a month with huge r:r based off certain context. Sometimes there are price insensitive positions being taken or closed by large entities that also represent great opportunities for smaller participants to quickly disseminate.

Even in present day, the market is a huge source of opportunity for individuals who are capable of utilizing it. You're going to hear a lot of conflicting opinions, pessimism, discouragement, bits of wisdom, vague platitudes, and more around these environments. No one can decide for you whether 20% returns per year are possible or not. If you continue to directly study and learn for yourself with an open mind I think the answer becomes clear quite quickly. But that's just my own belief; your mileage may vary.

Thanks for your reply. I'll keep studying and testing ideas to try to become a member of your group 3. I don't think I won't have any problem being patient and rational, that was something that I learned very well being a professional poker player. I only care about improving and making good decisions every day, I don't mind about short term results.

Could you recommend me any efficient way to learn?

 

[sysdevel99]

With options in the stock market, you are essentially acting like an insurance company buying or selling insurance policies to benefit or protect yourself from a move or non-move. Insurance companies can make decent and reliable money provided that solid mathematical choices are made and risks are addressed.

Here's the challenge with insurance companies. They make money but they take huge risks. Your crash example is like a mini earthquake or disaster for insurance companies. The ones that survive are the ones with deep pockets (and no leverage) or re-insurance (defined risk -> lower return). There's one additional category (think AIG) but unfortunately the government won't bail you out on option trades
I think insurance companies are just as many as option sellers (meaning it's an efficient market), so if you like 4-5 % return with high risk then that's realistic. The ones that make more are the ones that got lucky, meaning they sold insurance during non earth quake times or didn't hit outliers and retired before the quake hit. Same with the brownian motion, just like insurance sells permanently so do option sales, there's no edge in that either, you may get lucky though and think there is until you hit the outlier which just confirms the norm and give it back to be in line. Here's some backup on the 4-5 % in case you were wondering where the nbr came from

http://www.investopedia.com/ask/answers/052515/what-usual-profit-margin-company-insurance-sector.asp

 

[ktm]

Here's the challenge with insurance companies. They make money but they take huge risks. Your crash example is like a mini earthquake or disaster for insurance companies. The ones that survive are the ones with deep pockets (and no leverage) or re-insurance (defined risk -> lower return). There's one additional category (think AIG) but unfortunately the government won't bail you out on option trades
I think insurance companies are just as many as option sellers (meaning it's an efficient market), so if you like 4-5 % return with high risk then that's realistic. The ones that make more are the ones that got lucky, meaning they sold insurance during non earth quake times or didn't hit outliers and retired before the quake hit. Same with the brownian motion, just like insurance sells permanently so do option sales, there's no edge in that either, you may get lucky though and think there is until you hit the outlier which just confirms the norm and give it back to be in line. Here's some backup on the 4-5 % in case you were wondering where the nbr came from

http://www.investopedia.com/ask/answers/052515/what-usual-profit-margin-company-insurance-sector.asp

Good points.

Options (the insurance policies) can be sold/bought (to close) when the forecast grows cloudy. I tend to step aside when the VIX moves into the low 20's. What I do simply doesn't work in high vix environments. Imagine an insurance company that could cancel policies - at a small loss - when a hurricane is moving up the shore.

In my mind, short naked options are earthquake insurance in California. Spreads are more like hurricane insurance. The former is never in the forecast but the latter can never sneak up on you.

It's no panacea and you don't print money with the re-insurance needed to run a proper risk profile, but 20% per year is quite doable.

 

[Sig]

Not to get hung up on the term, but brownian motion is actually easier to predict than a stock price, and yet still completely unable to be predicted. Brownian motion describes the motion of a small, but not subatomic, particle suspended in liquid. That constrains it to newtonian motion, meaning it can't move discontinuously, i.e. it can't appear 3 cm from where it was a nanosecond before. And brownian motion has been shown to be completely unpredictable. The stock market (and insurance) have the added feature of gapping, a price can be 10% away from the previous quote in a nanosecond. Making it even less possible to predict. Sorry if that makes me a "naysayer"; I also say that all indicators point to it not being possible for a human to run a 1 minute mile or for anything to travel faster than the speed of light, so I suppose I'm just a hopeless pessimist. Or someone who bases their decision on empirical evidence.
Anyway, welcome to options for the OP, and be careful of anyone who can't back their assertions up with some reproducible studies and/or a rational discussion that involves at least undergrad level stats.

 

[sysdevel99]

, but 20% per year is quite doable.

As it was for AIG before it hit the fan.
Look I'm not saying you can't get lucky (and luck can last a career) but I've seen newbies enter the market a month before a crash just like I've seen some guys get out of it in April of 2010 avoiding the flash crash which may have changed their career. Those are the two tail ends in your distribution, with a ~ 5 % return return in the middle.

 

[llIHeroic]

Could you recommend me any efficient way to learn?

The basis of my trading method is an obscure branch of technical analysis. TA in the sense that instead of trying to predict future market movements or relying on public opinion to bend to fundamental conditions; the goal is to react successfully to other market participants and their actions.

I think if you're trying to get steep returns, you're likely going to have to use some degree of TA in your operation. What that's going to look like for you; I don't know. There's a huge variety of inputs that one can choose to research. Order books; price movement, volume per unit of time, volume weighted average prices...

Start asking yourself questions, and try to understand how and why the large players do what they do. Read through past threads and you should start to see genuinely successful traders who decide to contribute here occasionally. Maybe their posts will give you an idea to investigate. At this point just keep taking in information and trying to narrow down an avenue of more detailed study that sparks a degree of interest in you, or you have a bit of intuitive feel for.

Make hypotheses and test them as you learn. You can generate a ton of ideas and test them like a madman until you find something with a strong correlation. If a typical liquid stock moves in the same direction for five days in a row, and then the previous day's low is broken; Is it more or less likely to continue in the new direction than usual. Or is there no discernable difference created by that context? What if the initial move occurred on volume above the 90 day average? Or below? Does this change anything, or is there still no strong correlation.

That's just a single idea I came up with while writing this post. Maybe if I tested 50 of those I would stumble upon a really strong and reliable correlation to investigate further. Maybe if I combine several contexts, a seemingly repeatable pattern occurs. After a large enough spike in the VIX within a specific time-frame occurs; maybe there are a few pockets in the resulting reversion that can be reliably exploited by trading vol while properly hedged.

It's unlikely you'll get a specific step-by-step here. Usually individuals who've already undergone the gauntlet will show their results or share bits of their journey which you can incorporate into yours. Recently a member of the forum named monoid really impressed me with some of his posts. I've read some really interesting posts from sellindexvol66 in the past. A large part of my own paradigm of TA comes from a myriad of past work by Spydertrader and jack hershey. KDASFTG posts some real good stuff from time to time. There are quite a few more gems hidden amongst the bickering here. Hope that helps.

 

[galvinlee888]

The biggest doubt I have is whether it's worth trying to keep learning about options. Sometimes I feel like someone trying to beat roulette. Is it really possible to make positive expected value plays that would yield a higher return than just buying and holding the underlying, or the market is efficient enough to make it impossible? Are winners always people that have just experienced a good run, or are some of them really "playing" profitably?

Good you bring up roulette example.
As a professional poker, you did understand why no one can beat roulette in long term. The 0 bring the odd to the house (aka edge). In other word, you are paying commission / slippage (2.7%) to casino.

The mathematically edge from options will hardly bet the commission + slippage.The market is quite efficient this day in the option pricing.

Note I use "long term" above. Now times to think and stop asking people to feed you.

 

[Handle123]

It is very possible, but you have to approach options differently than most and you must be very educated and good at chart reading to keep risk low enough, and you must be very active in watching them, not as much as in day trading, but in my case, hourly. I been studying them with earnest past 3 years and have started trading them few months ago with model I have well back tested but based on underlying and not with the options themselves. I have found what an option should be worth compared to underlying does not have to be true, they at times have a mind of it's own. I didn't like using the Greeks much as it all sounded "greek" to me and generally too many play them so I didn't see enough edge of playing time decay and staying delta neutral. So I went different approach, trade them as chart signal but opposite most of time, if I expect stock/ETF to go up=take Put credit spreads, if I expect stocks/ETFs to go down=take Call credit spreads and both I average down at certain values of the instruments for so many levels and at certain point do both Call/Put credit spreads and lastly at some point do Debit spreads. All systems have to have an "Uncle" point, can't take unlimited adding on, but when get deep enough can somewhat offset one against the other.

There are so many different ways to trade options to your benefit cause the heavier traded options have great volume in many months, you can start out by doing longer term credit spreads and doing other side with monthly credit spreads, whereas in futures, volumes decline a good deal beyond first two front months. And you can also trade options on futures, they often give good bang on the buck.

I think of all the instruments I have traded, options are by far most exciting in my weird little way of time decay, often times like watching paint dry, only adding to increases probabilities of no worse than breakeven plus fees.

 

[Turveyd]

I presume, more than 1million poker games in a year is figuratively and definately not literally.

There are only 525,600 Mins in a year, so you'd have to play 2 games per minute for the entire year and sleep NEVER!!

Doubt you it 10,000!