It's like I said - anyone who convinces themselves that a systematic short vol strategy is profitable will not be persuaded otherwise.. no amount of reason or logic will permeate. In other words, your detailed and rational explanation will be ignored!
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Selling both Puts & Calls - Strategy idea
- Thread starter sondermark
- Start date
It's like I said - anyone who convinces themselves that a systematic short vol strategy is profitable will not be persuaded otherwise.. no amount of reason or logic will permeate. In other words, your detailed and rational explanation will be ignored!
No problem in a perfect world. You pick the strategy and the stock cooperates. But what if it doesn't?Quote from sondermark:
Day 1:
AAPL stock: $350.00
Sell May $350 Call: $7
Sell May $350 Put: $7
Pocket $14 and have $350 cash balance reserved for trade.
Day 2:
AAPL stock: $351
Buy AAPL at $351 to hedge Call sold
Option Expire date:
AAPL stock: $360
Deliver stock to call buyer, put expire worthless.
Profit is: $13 ($14 premiums - $1 lost on stock hedge) or 3.7%
Obviously, it is problematic is the price whipsaws the strike price as I will need to buy and sell the stock and thereby increasing costs.
Suppose after buying the stock on day 2 at 351, it drops quickly, say to 345 (don't assume that you can transact at any given price since markets can be fast). Now you have a 6 pt equity loss and maybe a 2 pt loss on the straddle. What are you going to do now? Hold on for an upside reversal? Suppose it keeps dropping? Now you're losing 100 delta on the stock as well as losing an increasing amount of straddle delta as AAPL drops more. What now? Take the loss on the stock and flip to being short shares? What if it now reverses?
Do you really believe that b/t now and May expiration, AAPL isn't going to have multiple trading patterns? You're likely to see big moves (more than the 1 pt buffer you suggest) with reverses as well as some periods of trading in a box (whipsaws). You need a better plan.
It might be the most natural thing to do for you, but for an institutional money manager the most natural thing is to buy stocks and protect them with puts every once in a while. There is a number of assets where the demand for vol outstrips the natural supply. JGB options is another example.Quote from meanreversion:
Who is consistently buying and losing money on S&P options? It's odd, when you think that the most obvious thing to do with options is sell them, and thus "collect" the premium.
Historical studies that I have done and that other people have done. Convexity sellers, as a general rule, demand a premium - thats economics 101. You can do a simple study yourself using public domain data - take VIX (which is implied fair variance for the front calendar 30 days, so square it) and SPX index, calculate rolling 21 day realized variance and see what average ratio of implied to realized you get. Take the past 20-30 years to make the test include all sort of Taleb eventsQuote from meanreversion:
When you say "risk premium", do you mean that implied vol is consistently higher than realised turns out to be? What makes you think this is the case?
Quote from spindr0:
You need a better plan.
Yes. Who hasn't considered this or a similar strategy - and who hasn't discarded it?
As sle suggested there may be overpriced options that would perform well with this strategy, but I would think that edge would be small and best left to veteran traders. Deeming options overpriced or underpriced is saying that the market is wrong.
And I doubt that very many would trade it without some other edge. Furthermore, if you can do all that, there's less risky approaches.
Quote from sle:
It might be the most natural thing to do for you, but for an institutional money manager the most natural thing is to buy stocks and protect them with puts every once in a while. There is a number of assets where the demand for vol outstrips the natural supply. JGB options is another example.
Historical studies that I have done and that other people have done. Convexity sellers, as a general rule, demand a premium - thats economics 101. You can do a simple study yourself using public domain data - take VIX (which is implied fair variance for the front calendar 30 days, so square it) and SPX index, calculate rolling 21 day realized variance and see what average ratio of implied to realized you get. Take the past 20-30 years to make the test include all sort of Taleb events
Are these the same institutional managers who lost truckloads when the market collapsed in '08?
I'm not disputing that occasionally end users purchase options for protection, that is fairly obvious. However, to imply that these options are always overpriced is wrong. BUT in the absence of a backtest on a short-vol strategy (which neither of us is prepared to do), we'll have to leave the quantitative side of the argument there.
I have traded options for many years, and during that time have encountered many funds (and individuals) who have attempted the short-vol strategy .... they all blew up in the end. Ok, maybe their money management was poor, maybe they didn't have the balls to cut the position, it's tough to say. But they all ultimately lost money.
Quote from sle:
Off the top of my head, S&P vol is systematically rich. A lot of single stock vols are systematically cheap, especially the ones that have a lot of revcon activity. By the nature of the beast, there are significantly fewer systematically cheap vols, but plenty of systematically rich ones.
That is not to say that it is rich or cheap at ANY given moment in time, it just means that in general it is so. You do believe in risk premium, don't you?
What is "revcon activity"?
I would never implie that any kind of options would be overpriced ALL of the time, but that they are overpriced MOST of the time.Quote from meanreversion:
However, to imply that these options are always overpriced is wrong.
I used to run a swaptions book at a dealer-broker and saw a lot of people that in general where better sellers of gamma. I am on the buyside now and these guys are still around. Does that mean that they where ALWAYS short gamma? No.Quote from meanreversion:
I have traded options for many years, and during that time have encountered many funds (and individuals) who have attempted the short-vol strategy .... they all blew up in the end. Ok, maybe their money management was poor, maybe they didn't have the balls to cut the position, it's tough to say. But they all ultimately lost money.
On a side note, majority of systematic mis-pricings do not necessarily make a good trading strategy directly. In this particular case, if you sold straddles and delta hedged them dilligently, in the past 20-30 years would have made money. Problem is that it's a strategy with a pretty low Sharpe so the fund managers in general try to pad it by never hedging. The results are obvious
With naked staddles, even if you get volatility right, price can still get you. Yes, best left to experienced traders.Quote from donnap:
As sle suggested there may be overpriced options that would perform well with this strategy, but I would think that edge would be small and best left to veteran traders. Deeming options overpriced or underpriced is saying that the market is wrong.
Quote from sle:
I would never implie that any kind of options would be overpriced ALL of the time, but that they are overpriced MOST of the time.
I used to run a swaptions book at a dealer-broker and saw a lot of people that in general where better sellers of gamma. I am on the buyside now and these guys are still around. Does that mean that they where ALWAYS short gamma? No.
On a side note, majority of systematic mis-pricings do not necessarily make a good trading strategy directly. In this particular case, if you sold straddles and delta hedged them dilligently, in the past 20-30 years would have made money. Problem is that it's a strategy with a pretty low Sharpe so the fund managers in general try to pad it by never hedging. The results are obvious
I thought short vol was the ultimate high Sharpe strategy, a la LTCM ... ?
The funds and punters who've made the most money from options over the years are those who've taken long vol positions, whether it was buying IDR vol at 3% just before the Asia crisis, or CDS just before sub-prime (a proxy option with outlay so minimal).
Selling options is very seductive. It appeals to all our biases - high win ratio, money upfront, profit if "nothing happens" etc.
Actually, I am willing to bet that it's not true. While it's very easy to say "if you bot vol here you made out like a bandit", in general picking bottoms in vol is just as hard as in any other asset. I am sure people who ONLY buy options as a strategy have done very poorly over the years.Quote from meanreversion:
The funds and punters who've made the most money from options over the years are those who've taken long vol positions, whether it was buying IDR vol at 3% just before the Asia crisis, or CDS just before sub-prime (a proxy option with outlay so minimal).
Funds that made money trading vol are, in general, relative value players like myself. E.g. selling S&P gamma naked is pretty scary, but if you doing it as a term structure trade or as relative value against another index and so on.
Short puts, not hedged short gamma.Quote from meanreversion:
I thought short vol was the ultimate high Sharpe strategy, a la LTCM ... ?
Yeah, while being long gamma has it's own psychological appeals (can only lose as much, less anxiety etc). I, personally, HATE being short gamma as a human being, while I know that in many cases it's the right strategy.Quote from meanreversion:
Selling options is very seductive. It appeals to all our biases - high win ratio, money upfront, profit if "nothing happens" etc.