It sounds like you are talking about selling a spread and just leaving it alone?
Is there any empirical study available about the profitability of option sellers vs option buyers?
- Thread starter Lloyd W. Coutee
- Start date
It sounds like you are talking about selling a spread and just leaving it alone?
Probably the best way would be to consistently put on a short straddle and a long straddle on the same underlying at the same time (in two different accounts) and see over time if one side or the other ever makes money, and then write your results in a study and call it empircal.
Maybe I should do that with a few hundred dollars for a year or so, and write a report
There have been academic papers talking about the profitability of index option writing strategies and most of their results can be replicated. In general since 1987 option sellers have an edge. But the real world is not simple, it largely depends on your leverage. If you are selling a spread with small leverage, no matter how black the black swan is you will still be OK. If you got greedy and use high leverage then the event risk could not be hedged out and you will live a shorter life by worrying too much about the opening gap every single night.
Is there any empirical study available about the profitability of option sellers vs option buyers?"
Considering that a very high percentage of options expire worthless (a well known fact) , then it's safe to assume that the option sellers are profitable.
But the few option traders/buyers...that are successful, they have much larger percentage returns -- compared to the option sellers who collect/pocket that relatively small premium sum.
Here is a study on the percentage of options expire worthless statistics:
So the statement that most options expired worthless is not quite true, at least not true for the year 2006. That said, why more expired worthless than exercised? If you look at open interests, you should find more OTM options than ITM because many believed that selling OTM options are more profitable with higher probability of profits. So it is not surprising that more expired worthless since there are more OTM options around.
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My gut feeling is that selling options has better prospects, for once since there are 100,000 stocks out there with little liquidity so there's a much smaller market for buys than for sells.
I'm currently working on a software product which I use for backtesting option replication (daily rebalancing) across a variety of underlier types (stocks, stock indices and fx) and names. So far I got somewhat normally distributed returns, but there's a definite skew on the large losses side.
So I can tell you several things:
1) The safest way to sell options is to also buy options to protect yourself from large jumps (exactly what Taleb says).
2) If buying options is not an option (you're a market maker) then you still got two options
a) Add more premium. Add a lot of premium as with probability 1 you will incur large losses.
That's easy to say but if others sell at 0.05 spread, noone's gonna buy at 0.5 although it would be the fair price on the long term. Maybe I've seen too many conspiracy theory movies but I suspect one of the reasons the spreads are so unsustainably low, leaving aside the small suckers who don't know what they're risking, is because the big players never intend to actually pay those large losses, when it will hit them. Remember, they're "too big to fail"
b) Something else which I'm eventually discussing in private, after enough trust has been established.
I'm currently working on a software product which I use for backtesting option replication (daily rebalancing) across a variety of underlier types (stocks, stock indices and fx) and names. So far I got somewhat normally distributed returns, but there's a definite skew on the large losses side.
So I can tell you several things:
1) The safest way to sell options is to also buy options to protect yourself from large jumps (exactly what Taleb says).
2) If buying options is not an option (you're a market maker) then you still got two options
a) Add more premium. Add a lot of premium as with probability 1 you will incur large losses.
That's easy to say but if others sell at 0.05 spread, noone's gonna buy at 0.5 although it would be the fair price on the long term. Maybe I've seen too many conspiracy theory movies but I suspect one of the reasons the spreads are so unsustainably low, leaving aside the small suckers who don't know what they're risking, is because the big players never intend to actually pay those large losses, when it will hit them. Remember, they're "too big to fail"
b) Something else which I'm eventually discussing in private, after enough trust has been established.
> The safest way to sell options is to also buy options to protect yourself from large jumps
Except those tail options are always expensive, in IV terms. Everyone wants to be Nassim.
Except those tail options are always expensive, in IV terms. Everyone wants to be Nassim.
Yup. In fact I've thought this could be an explanation of the volatility smile even for the case when stock returns would be perfectly normal (though they are not). Even if the tail options are clearly overpriced, there's still a pressure to buy them, which drives prices up.
I don't like the idea of buying insurance hoping you can cash in and make a profit. Whether it is car insurance, or homeowners insurance, or especially life insurance.