Is theta really an edge?

Quote from sle:

First of all, the only people who actually have an "edge" are marketmakers. They are buying low, selling high and are trying to lock that edge in. Everyone else is just trying to extract alpha out of the market.

Second of all, thinking that you know something that nobody else knows is an extreme flaw. There are so many smart people kicking around the markets, pretty much anything you could have thought of has been thought of before.

My personal view on this is that selling risk premium does have some alpha, but that alpha is there for a reason. So yes, over a hundreed years of selling premium you would probably make money, but (depending if you are running your own capital or OPM) you would end up bancrupt, with broken kneecaps or fired.
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We agree for the most part. I am curious about your thoughts on the reason alpha is there.

Market makers trade differently from most of us here. The assumption that they do the same things we do causes many to lose money.

To clarify. I didn't say that nobody else knows these things, merely that the knowledge is not known by many that I trade against. Ken Fisher talks about this same concept in his books.

Finally, I am not perfect. Letting go of perfection gives you great freedom and better trading abilities.
 
Here are two excellent papers that explore these kinds of questions - albeit from a volatility, not theta POV. (Being short volatility on most vanilla options implies being long theta - although I'm sure martinghoul and sle could give me 100 examples where that is not the case.)

For those who don't want to wade through all of this, the general conclusion is that an appropriately-structured short volatility position provides a moderate long-term edge over a long period of time. It's not easy, however, and the drawdowns can be steep.
 

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Quote from sle:

First of all, the only people who actually have an "edge" are marketmakers. They are buying low, selling high and are trying to lock that edge in. Everyone else is just trying to extract alpha out of the market.

Second of all, thinking that you know something that nobody else knows is an extreme flaw. There are so many smart people kicking around the markets, pretty much anything you could have thought of has been thought of before.

My personal view on this is that selling risk premium does have some alpha, but that alpha is there for a reason. So yes, over a hundreed years of selling premium you would probably make money, but (depending if you are running your own capital or OPM) you would end up bancrupt, with broken kneecaps or fired.
More...

To further SLE's point, how many vol funds have a lifespan of more than 5 years? Not that many. In the set that have succeeded for more than 5 years, 90% will be market makers.
 
Quote from sle:

First of all, the only people who actually have an "edge" are marketmakers. They are buying low, selling high and are trying to lock that edge in. Everyone else is just trying to extract alpha out of the market.
More...

Whoa...this little comment goes very deep. I feel my worldview shifting...

If I promise to make offerings on my alter asking the Heavens to grant you long life and great wealth, would you kindly explain this further? :-)

Thank you
 
Quote from TskTsk:

I am usually naked short, haven't blown up yet. Everytime I pray to god it wont blow up and it seems to be working so far.


Yes thats what I'm thinking too, but I just cant ignore all the people claiming there is. Would love some more in depth response if anyone has
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I think depending on God is a high risk strategy!
 
when a stocks RSI is at 120 and been over bought for some time.. i wouldn't sell puts... i would try buying them... when the market has continually taking a crap like in October.. i would be more net short volatility.. but being exposed to a complete risk of ruin is not gonna keep you in the game... whats making a million dollars in martingale selling premium strategy if you lose it all in one large mistake.. There are definitely times to take on large amounts of risk at the sake of making premium... IE put credit spread.. say if you have 100 grand to invest.. put 2500 to 5000 dollars up on margin to make 500 to 1500 dollars.. or look for that alpha stock that got hammer as a result of a huge market sell off.. apple.. msft whatever... sell cash secured puts.. don't be scared to take a position... or learn to gamma scalp.. IE sell naked puts... if your the stock goes against you short/collar it to neutralize your delta risk. and freaking READ MORE!
books i've recently read..
Options market making..
trading options as a professional
my statistics book from college
ANYTHING you can find on understand pricing models
know the greeks.. how to neutralized your risk!
money management, risk management.. position sizing.. LEARN IT OR LOSE..

no free lunches.. model your trades.. have targets and exit strategies ..

oh and if your buying near term options out of the money.. your only stop is the exact premium you paid..
 
Lots of talk about blow-ups. But little talk about spreads, which makes potential losses finite. Does that still count as theta, or is it really gamma? Either way, I think spreads are a great way to go.

My opinion is that selling premium has a slight advantage, because not everyone in the options market is a speculator / trader / whatever. Some buy options in order to dispose of risk, and consider the money well-spent.
 
For it to be an edge, implied volatility has to be different from what realized volatility turns out to be. (Higher if you are selling options. Lower if you are buying them.)

If you are selling options, you have to look for those cases where you believe your judgment as to future volatility is better than that of the market and/or you can pick the direction of the market. You also have to watch risk of course.

There are also certainly times where you may want to buy options where they are under-priced in your market view.
 
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