Just wondering: Why isn't premium selling considered alpha
- Thread starter dcwriter2
- Start date
Was a long discussion on Twitter about this. Alpha is what is left over after Beta and other risk factors.
But Beta can include 'alternative beta' which is any source of return that can be replicated by a well known simple strategy. So a simple vol selling is not alpha. Of course we can argue about what simple is
GAT
But Beta can include 'alternative beta' which is any source of return that can be replicated by a well known simple strategy. So a simple vol selling is not alpha. Of course we can argue about what simple is
GAT
What is *alpha*?? (I mean, besides being one of the most abused and misunderstood terms in finance -- right behind "risk", I think...)
Define "alpha" and then define "premium-selling", and see if you can put an equals sign between 'em. (You can't.) ((Or better, you *shouldn't*.))
Define "alpha" and then define "premium-selling", and see if you can put an equals sign between 'em. (You can't.) ((Or better, you *shouldn't*.))
For example, if you just short 1 contract of VIX, you will make money over the long run. But this requires no skill, so clearly Beta. You don't need 'risk management' as you're not trading, only enough money to make sure you don't get blown up.
I trade VIX using an inverse volatility position weighting, plus carry, momentum and RV mean reversion signals, with a proprietary portfolio risk adjustment. Maybe some alpha here?
But where is the dividing line?
GAT
I think that “enough money to make sure you don't get blown up” means risk management. And it may not be so simple because you can still lose on VIX options, so you have to use small position sizes that may limit your returns below just holding SPY that VIX is a type of derivative of. If your returns are better than holding SPY then you have alpha, IMHO.
Or if you’re selling options on AAPL and beating AAPL stock then you have aloha as well.
Of course the details of alpha can be argued, but I think the OP simply means “profit” beyond max available risk-free rate, and even regardless and without relation to specific stock - because he would simply want to be profitable every year, or at least wouldn’t want to lose even when the underlying goes bad, or at least would like to have anything that anyone could see as better than they would’ve gotten by doing less work or less trading.
And btw, there are lots of super-smart people backed by lots of $cash whose jobs are to invent new ETFs that can simply be profitable every year, regardless of the level of “alpha”, so if this could be done in a simple and automated way with VIX options then we’d see at least a single ETF that’s simply profitable every year. While there already are ETFs based on selling SPX options, some become defunct because they were useless.
So you may be doing something much better than people with “no skill”.
Sure but most basic risk management doesn't need skill. If I sell one VIX future then my delta is $1000 a point. The largest ever spot VIX move was 20 points. So that's an extreme loss of$20,000. If I wanted to lost at most 50% of my capital on such a move I'd need $40,000.
None of these calculations involved anything like 'skill': a child could do them. A more complex risk management methodology arguably needs skill, but if still based on published work does it count as 'alpha'?
GAT
Ah, many people come here asking for help with finding alpha, while you're saying that as soon as such information is published it's not longer 'alpha'. So even if you did have an alpha and described your approach then it no longer would be alpha, thus making "prior alpha" no longer alpha. Or something like that - it's just a bigger can of worms. I also saw alpha defined as "beating the market return over some period", which makes it subject to further interpretation (https://www.investopedia.com/terms/a/alpha.asp).
So really no way to ever agree what's actual alpha and whether you have it.
But I think that for normal people, for example when you wanted to tell grandma how well you're doing, you could just say that you're making more money than keeping money in the bank or in stocks in general. And that's even how investors look at hedge funds as well - all they want is to put money somewhere that outperforms SPY, or at least pays more than Fed interest rate (preferably both). That's sufficient alpha for them, and not easy to find either.