Quote from rallymode:
Trendsailor,
I have my best wishes at heart when i say this. Please burn all Optionetics seminar materials and pick up a real options book. Your knowledge on options is deeply flawed. No offense.
No real offense taken. I am here to learn. Honestly, I appreciate your sentiments and insight. I am definitely not an
expert options trader - I'll admit that right up front. But I am not sure such a term has relevance since if what a lot of people here are saying is true then an expert would not be doing options at all since there is so much negative expectation and everyone is eventually going to go bust in the long run.
But let's step back to the insurance model. Are you telling me that in spite of record profits for many insurance companies that in the long run its impossible for insurance companies to make money? Or are you telling me that the insurance model is fine but its impossible to get a properly valued price for options given the real risk when writing them because the market has an a-priori unfairness built into the pricing structure to get more trading volume? If the latter is what you are telling me then clearly the market makers and brokers have structured the system as a casino and gamed the system so only they win in the long run.
I am comfortable with the fat tail concept of the probability distribution. But if one can assume a reasonably normal shaped price distribution in a random market theory then statistically one can fairly consistently make money by selling options at the 1 - 2 sigma price swing expectation. This is from the 68-95-99.7 rule for normally distributed data. This means that about 68% of the values are within 1 standard deviation of the mean, about 95% of the values are within two standard deviations and about 99.7% lie within 3 standard deviations( ref
http://en.wikipedia.org/wiki/Standard_deviation).
The confidence intervals are as follows:
Let S mean "sigma" (standard deviation) since this system apparently does not like greek.
S 68.26894921371%
2S 95.44997361036%
3S 99.73002039367%
4S 99.99366575163%
5S 99.99994266969%
6S 99.99999980268%
78 99.99999999974%
I understand that historical volatility are imperfect predictors of future volatility just as much as insurance actuary tables are imperfect predictors of life expectancy but the practical results both in predictive power and in pricing in the insurance industry are good enough to insure net wins. There will of course be a similar single event "fat tail" wipe out event in the insurance model but I think insurance companies hedge this by pegging total liability in the contract policy and with cheap hedging and with risk reselling (and maybe with political favors, an occasional bailout and good lawyers).
The advantage options writers have is that they can buy out "the policy" as real perceived risk starts trending against projected risk. This should make it possible in theory for writers to do even better than insurance companies. Also, given the momentum effects of underlying price trend and the time it takes to change direction within a relatively small window of an option's active period and the directionality uncertainty it just "intuitively" looks like buyers of options are at a severe disadvantage to sellers.
The bottom line is that I have imperfect knowledge of options. But the arguments that are presented to say option writers have a net negative expectation must all assume a grossly undervalued option premium for the given risk and this unfairness must be germane to the market mechanism itself. If that is the case then EVERYONE trading options (buyer or seller) is essentially gambling with no net positive expectation and all this "expert" discussion is mute and delusional or a matter of religious belief. Pity us all in that event.
When writing options the model I am operating to is salesman of "security or value insurance". If I can not get what I consider to be a fair price in a a period of normal risk or I think a financial storm is brewing (VIX, earnings reports, political change etc. ?) I don't sell a policy. If you are telling me its impossible to get a fair price because the markets are intrinsically not fair then I need to reevaluate options completely or view them in the same manner I do casino gambling - as entertainment.
Thanks for your comments,
TS
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when it comes to placing partial hedges. everytime I put one on the market reverses and my short strike is safe. The market knows what I am doing and reacts LOL