option profitability question

option profitability question

  • Options

    Votes: 2 50.0%

  • Trading

    Votes: 2 50.0%
  • Total voters
    4
A

aplino

My question is expressed better with a hypothetical example.

Let’s say that there is a strategy to trade a spread and the probability to win $0.3 is 70% and the probability to lose $0.7 is 30%.

I do not see any advantage taking trades like that.

Some people claim that this can be profitable in the long term by closing trades early. Others talk about the IV that might affect the results that I do not understand why in the long term.


Any thoughts?
 
aplino said:
My question is expressed better with a hypothetical example.

Let’s say that there is a strategy to trade a spread and the probability to win $0.3 is 70% and the probability to lose $0.7 is 30%.
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That's not a hypothetical example; it's a perfectly reasonable distribution of expected gains and losses at trade entry. All initial trade entries have, at best, zero expected value. If they didn't, everyone in the market would pile into whatever trade had positive EV and instantly arbitrage it away.

I do not see any advantage taking trades like that.
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There's no other kind - except for those where you make one of a very large variety of mistakes, at which point your EV goes negative. Your lack of understanding of this fundamental fact is one of those mistakes - which makes your current EV on any trade negative. I'm not saying this to be mean, or hide some deep secret from you; it's just that your question is similar to someone asking how to do differential equations while arguing that the "plus thingie" shouldn't work like it does.

Some people claim that this can be profitable in the long term by closing trades early. Others talk about the IV that might affect the results that I do not understand why in the long term.

Any thoughts?
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Yep. Learn to trade - perhaps starting with stocks - and stay far, far away from options until you have a solid foundation of understanding backed by sufficient experience.
 
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As a retail, entering an option position comes with a negative EV, however by adjusting the position one can turn it into a positive EV position. Although that means the initial position has to move in your direction, so it could already be closed for a profit, but statistically by adjusting these positions into positive EV, you'll make more money in the long-term.
 
Trading options is more about inefficiencies in probabilities. You're looking for something that is consistently over priced or under priced. Implied volatility against historical volatility. Expected price movement against actual price movement. In your example, the probability to win $0.3 is 70% and lose $0.7 is 30% - that's what the market is pricing in. If you have reason to believe that pricing is incorrect and you're probability to win .3 is really 80%, there's your edge.
 
Trade Theory said:
Trading options is more about inefficiencies in probabilities. You're looking for something that is consistently over priced or under priced. Implied volatility against historical volatility. Expected price movement against actual price movement. In your example, the probability to win $0.3 is 70% and lose $0.7 is 30% - that's what the market is pricing in. If you have reason to believe that pricing is incorrect and you're probability to win .3 is really 80%, there's your edge.
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The 'market's pricing is always correct, it is your pricing model that is not ...
 
Stamamarti said:
The 'market's pricing is always correct, it is your pricing model that is not ...
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The market's pricing is almost never exactly correct. It can be very efficient where most of the time actual movement is very close to what's priced in. And when that's the case you want to trade butterflies around it. You want to think in terms of a distribution curve.
 
Tony Optionaro said:
As a retail, entering an option position comes with a negative EV, however by adjusting the position one can turn it into a positive EV position. Although that means the initial position has to move in your direction, so it could already be closed for a profit, but statistically by adjusting these positions into positive EV, you'll make more money in the long-term.
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So true. That is why often time I was depressed after I put on a trade, knowing right off the bet I was already behind the 8 ball. :mad:
 
ironchef said:
I don't think you will find that. At least I never found anything consistently under or over in the 7 years I traded options. :(
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The easiest way to quantify the consistencies or inconsistencies for me is by visualizing it. In this screenshot, the middle row shows implied volatility displaced against historical volatility. Its an ever changing environment so you would need to adjust your length depending on how long or short term you are trading and re-analyze it each time you place an opening order. August - September historic vol was higher than implied vol in the SPX. So during that timeframe you would have wanted to be net long premium (debit spreads). Another way to analyze this is by mean reversion demonstrated in the bottom row. Implied vol with a simple moving average overlayed. Right now the market is extremely efficient (imp vol is roughly equal to historic vol) so the way I'm positioned is trading butterflies against the expected movement determined by the implied volatility.
Capture.PNG
 
aplino said:
My question is expressed better with a hypothetical example.

Let’s say that there is a strategy to trade a spread and the probability to win $0.3 is 70% and the probability to lose $0.7 is 30%.

I do not see any advantage taking trades like that.

Some people claim that this can be profitable in the long term by closing trades early. Others talk about the IV that might affect the results that I do not understand why in the long term.


Any thoughts?
More...

I have a thought. Take 5 minutes and construct a coherent question.
 
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