SPX Credit Spread Trader

[cohenmichaela]

You say OTM options are "drastically underpriced". This is interesting to me. I'm not disagreeing with you but I always thought for the most part options markets were fairly priced and there's no implicit edge without having a volatility or price bias. With this in mind you're saying that even with the skew the OTMs are cheaper (have less IV) than you believe they should.

From my understanding I believe the primary reason for the skew is a high kurtosis of the actual price distribution. Thus, the volatility skew is primarily a result of modeling an option with an inefficient price distribution. Using my fair markets assumption the skew would be completely flat if we knew an exactly accurate distribution for the specific underlying.

I imagine there's quite a few people in the world who trade by taking advantage of the differential between the IV skew and the fair price based on a more accurate (or at least they believe more accurate) distribution of an OTM option.

Are you saying that the public drives the price of the OTMs down or that the MMs don't accurately guestimate the distribution and thus assign a lower IV?

Thanks In Advance,

-Michael

P.S. - I miss riskarb. I'm sure he'd have a 2 line response to this that would require me to spend the next 6 months translating it.

Quote from Maverick74:

Eric,

Here is the rub. ...

 

[yip1997]

Quote from kapil:

This is what happened to LTCM. They were averaging 40% per year until they went away.

No. LTCM failure is a different story. The major problem for them is risk management. They basically averaged down. Position sizing is the key for trading success.

The reversion of mean is theoretically correct and the strategy works only if you survive long enough. Same thing for martingale.

 

[dagnyt]

Quote from kapil:

Thanks Mark,

I guess I am trying to get a handle on what kind of ROE you guys shoot for. I agree we all have different risk tolerances but when you are trying to compare investment alternatives, total return counts. If you don't mind sharing, what is your target for ROM vs. ROE?

As you say, everyone has different goals.

My target for DDs is to increase the portion of my equity that I devote to DDs by 4% per month. I'm know Murray has done better.

Mark

 

[Cache Landing]

Quote from Maverick74:

Eric,

Here is the rub. ......

Many people seem to miss this point. So it's not a matter of how to trade this strategy but rather an understanding.

Great post Mav!!!!

 

[kapil]

Quote from dagnyt:

As you say, everyone has different goals.

My target for DDs is to increase the portion of my equity that I devote to DDs by 4% per month. I'm know Murray has done better.

Mark

4% per month is excellent. If I remember correctly, you do them for credits so they are much wider than Murray's.

 

[dagnyt]

Quote from yip1997:

Mark,

Your statement is not entirely true.

It really depends on your point of view.

Depending on your exit or adjustment strategy, the return on capital might be very important. For example, because I use very active adjustment strategy for DDs, I reserve half of my capital for possible adjustment in the first week. My reserve will decrease as time goes by, and my reserve will increase in the last week when adjustment is needed.

To me, I don't think DD is risky when I have reserve for adjustment. However without reserve, DD is very risky to me. So my reserve is actually working for me, and I think it justified to consider the return on capital.

I never look at a single spread or diagonal for adjustment. Always consider the overall portfolio to assess my risk and reward.

Let's say you have 100k and decide that 10k is all you care to devote to the DD startegy. If you earn 1k for the month, you may not think is method is very productive because you only earned 1%. OTOH, I would say that the method worked well and returned 10%.

This is NOT a big deal. As I said anyone can keep books in any manner that provides useful information.

Mark

 

[TrendSailor]

OK summarizing all that I have picked up here lately and combining with external reading and personal experience it seems that in addition to good money management, optimum position sizing, trading ability & risk management it seems like we need just two more things to be "successful" at options trading:

1) A good measurement of volatility change relative to the fairness of option pricing to gain a positive expectancy and an "edge" or to facilitate knowing when to close out or hedge or
swap one Greek for another; and

2) "Good luck" with a long run of wins so we don't spend all our daily time fighting the market to "get ahead" for any given month our expectation is out of sync with reality.

Or is this all rolled up into the fuzzy semantic of "good trading skills"?

Sigh - on a personal basis I am going to be very disappointed if I find out that a very early retirement ends up in practise being more work than a traditional "day job"; and that I need to escape trading and get back to "work" to get a vacation again...

TS

p.s. Selling cheap gamma ICs seems to be synthetically equivalent to buying "cheap thrills" with a curiously potent over the counter "time delay adrenaline fix". I wonder when FDA is going to ban the sale of this stuff without having a license or a prescription?

 

[domestic]

mav,

i cannot be the only one wondering if you consistently trade options? if so, then can you give us an idea how you trade? i do not mean actual trades; what types of trades(ie: ratio long/short combos, debit spreads, straight long or short, etc ?).
i have been here a long time and tried to search where you may have answered this, but i fell "short".

thanks in advance.

 

[rallymode]

Quote from domestic:

if so, then can you give us an idea how you trade? i do not mean actual trades; what types of trades(ie: ratio long/short combos, debit spreads, straight long or short, etc ?).

I think mav has consistently mentioned that he is a short gamma trader. That encompasses quite a few methods and/or styles. I doubt he uses any one method in isolation.

 

[El OchoCinco]

I think the point is that they are drastically underpriced when the black swan move is taken into account. There is no way to effectviely price in a 150 point drop in the SPX which could occur if some dirty bombs go off. So when considering THAT kind of risk, the point is the options are underpriced. It does not mean in general that they are selling at a nice discount.

Quote from cohenmichaela:

You say OTM options are "drastically underpriced". This is interesting to me. I'm not disagreeing with you but I always thought for the most part options markets were fairly priced and there's no implicit edge without having a volatility or price bias.