Statistical edge with option spreads -none?

Quote from timbo:

What's not obvious is the wet blanket mentality of academics and the like. But statistical edge exists.
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Well, I would agree that statistical edge exists, but I am just referring to pure options position and disregarding fundamental and technical factors. I tried to mean when picking a random option at a random time without any mispricing throughout the strike range, there isn't a statistical edge of one position versus another --or that is what I assume.

There's a whole field of statistical arbitrage, but I think this is usually taking into account of analysis of extraneous factors like volatility, fundamentals, technicals, etc. I suppose you might be able to construct an option position to exploit pairs trading, but I'm not sure if that would be worthwhile either.

So anyhoo, from the replies that I got from dmo to spin, I gather my hunches are not far off from the mathematical truth. This will prevent me from making overly complicated positions with big commission penalty.
 
If you mange the risk well and if you are not forced to overpay when buying or collecting too little when selling, you will have success.
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I am simple minded to just compare historical volatility with implied volatility to tell me if an option is mispriced or not? Other than that, if I were to analyze the stock then I would just consider the stock mispriced and not the option...
 
Quote from optionsgirl:

We read about the implied statistical edge concerning options all the time, but it seems that there is no statistical edge with any options strategy that I can think of. Now my mathematical aptitude isn't that great, but this is why I am posting it here for critique. I think most option strategies act more or less as a stop loss. Supposedly, the most conservative strategy would be a butterfly, but is it that much more conservative than a regular vertical spread? If there isn't a statistical edge with a butterfly over a simple vertical spread, then people are losing money on commission.

Here is a pattern that I see with a 50/50 chance with a random option. Get out when I double my money. Get out when I lose half. Double your money. Lose half. Double your money. Lose half. If I started with $100, I would end up with about $100 (not counting commission) no matter what the strategy is. Obviously, this isn't a realistic scenario, but it's just an idealized illustration of profits and losses with option hedging.

I thought there is a statistical edge with a far out-of-the-money short spread. This would be a steady trickle of money, but I think once in a while all those pennies will be lost by a major move and you end up about breaking even again.

I realize this is quite an inaccurate way to describe statistical probabilities, but this is just my guestimation that there is no statistical edge with options --or at least anything worthwhile. I think the only way to have an edge is to predict one or all of these things: implied volatility, historical volatility, and price movement of the stock.
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No strategies give you any edge. Excluding commission, any single option gives you zero expectancy. Expectancy of a combination of options = sum (expectancy of each individual option) = sum (0) = 0

Theoretically, if you pick any option randomly, you can't find any option that gives you 50% of winning 100% and 50% of losing 50%. If such option (or option strategies) exist, that means there is an option that gives you a positive expectancy.

Your edge should come from something else. It might come from Mark's or Coach's advices. It might come from predicting future IV.

Bottom line: You need to have a strong risk management to make it work for you.

[edit] I never read about the implied statistical edge concerning options. Can you give me a link or a pointer? I like to read about such edge that should not exist.
 
Just comparing historical to implied is not sufficient, although it does help somewhat with decision making. That is, if the implied is high, you need to ask why, but if you are working with an index, you may have a modest edge if the implied is very high since it does tend to revert to the mean eventually. What this means is that you have a slightly better than average chance of declining volatility during the holding period.

A mild edge, perhaps?

You also need to look at the volatility "smile". Sometimes OTM calls are really cheap relative to OTM puts or vice versa. This obviously affects your strategy selection. Significant skew between months can be a useful factor in strategy selection, as well.

Using this information wisely can improve your edge. It is a type of mispricing. For example, during January and February and March, index call options (SPX) were priced at very low values. This meant that Iron Condor strategies were not particularly wise during this time frame, and those who saw the market rise sharply paid a nasty price for selling cheap calls.
 
I think you guys talk about one and the same thing. While a lot of the successful institutional options traders (sell-side, hedge funds...) make consistent money by buying options they believe are trading below fair value and selling those higher than they perceived fair value the way they identify those are through their models and strategies. So, the price you pay, the timing of entry, how you manage your hedges is a function of the strategy you employ. Simple as that. So, yes, there are is/are some index option models out there that exhibit a statistical edge, meaning they statistically outperform the identification of fair value vs what other traders perceive as fair value.

I agree that there is no out-of-the box solution that works. I was taught and learned a model or two that looked like they worked very well but I employed a lot of changes and tweaked here and there to make them work for my trading style.

Quote from dmo:

Are you saying that there are strategies that give you a statistical edge regardless of what you pay? I hope you will share them with me.
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that is nonsense. The same set ups that some of the top prop desks have in trading index options, for example, can be easily employed at home. The biggest perceived difference is transaction costs and the time to set up those systems. Sometimes extensive programming and development skills are needed to code a platform that easily extracts the implied vols from traded prices, to calibrate my models and then identify other "mispriced" options. But it can all be done.

Quote from spindr0:

+1 for that conclusion.

I believe that it's possible to find set ups where there's a statistical edge but as you noted, nothing worthwhile. Retail (us) can't find enough of them and in sufficient size to get anywhere.

I'd also add to your list: appropriate strategy selection for the environment you're in as well as disciplined money management
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Theoretically, if you pick any option randomly, you can't find any option that gives you 50% of winning 100% and 50% of losing 50%. If such option (or option strategies) exist, that means there is an option that gives you a positive expectancy.
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Well, I was speaking in a relative sense. Here is an example for WFC options:

June 17 put: 0.38
June 20 put: 0.90
June 23 put: 1.90

If I bought a June 20 put, I would assume there would be a 50 percent chance that the stock would go down $3 and a 50 percent chance that it would go up $3. It isn't exactly a 50% loss and 100% percent gain, but it's roughly close. I suppose this isn't very accurate since the chance of a $3 move either way isn't really 50-50, but I still assume the chance of a $3 move up is about the same as a $3 move down.
 
Quote from dmo:

...or you can bet that a roll of a die will come up 6.

...If you can pay less than fair value for one but not for the other, then obviously the less-than-fair-value bet is the better bet.

...So success depends really on the skill of the option trader in finding bets that are underpriced. There's no one strategy that is always underpriced more than every other, so there cannot possibly be a best strategy.
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Continuing with the dice analogy here is an excellent explanation (courtesy of Maverick74 on 04-19-06):

"Let's try this for a minute. Let's remove the whole idea of the greeks. Let's simply look at options as a bet on fair value. When I interviewed in Chicago for the first time to work for a market making firm on the floor, all the companies asked this question.

They said you are going to play a game with one six sided die. You roll the die, whatever number comes up, you get that much money. So if you roll a 3, you get $3. If you roll a 6, you get $6. You are going to play the game over and over again. There are two players in this game. The roller and the house. The house is selling the bet, or selling premium if you will. The roller is buying the juice. The question is, as the roller, how much would you pay for the right to roll the die. Then, when you are the banker, how much would you sell the bet for?

For most of you you can figure out this is a very simple probability game that you probably played in your stats class in college. The fair value of the bet is 3.5. You get this number by summing the outcomes and dividing by the total.

(6+5+4+3+2+1)/6=3.5

That means the fair value of this bet over a long series of throws is 3.5. So if you are the roller, you want to pay less then 3.5 for the bet, say 3.4. If you are the banker, you would want to sell this bet for more then 3.5, say 3.6. What you just did is you made a market. You are 3.40 bid at 3.60 offer.

Folks, this in a nutshell is what options are all about. It does not matter if you are the roller or the banker. The person buying the premium or selling it. If you buy the option below fair value, you will make money. If you sell it for more then fair value, you will make money. Market makers have been doing this since 1973 and nothing has changed since then except the technology.

The whole idiocy of buying vs selling premium is as bad as the whole red state/blue state garbage. If you can grasp this very simple concept, trading options will become much more simpler for you.

Yes, over the long run, the buyer of premium will generally outperform the premium seller for one reason and one reason only. Not because he/she is a better trader. But because of something called luck. That's right, luck. Luck, is very much like volatility in that it doesn't have a positive or negative bias. It simply is what it is. You will have both good and bad luck in your life. The difference here is that when you have good luck as the long premium trader, you might retire off of it. Bad luck to the option seller will bankrupt him/her. Good luck will do nothing for the option seller as there is very little upside in what they are doing."

http://www.elitetrader.com/vb/showthread.php?s=&postid=1044299&highlight=dice#post1044299

Everyone here seems to have their own definition of 'statistical edge'.

Placing any option spread is not a "set it and forget it" strategy. Anything can happen at any time and you need the "edge" (i.e., money management ability) to modify/adjust your position when and if needed.
 
Quote from optionsgirl:

Well, I was speaking in a relative sense. Here is an example for WFC options:

June 17 put: 0.38
June 20 put: 0.90
June 23 put: 1.90

If I bought a June 20 put, I would assume there would be a 50 percent chance that the stock would go down $3 and a 50 percent chance that it would go up $3. It isn't exactly a 50% loss and 100% percent gain, but it's roughly close. I suppose this isn't very accurate since the chance of a $3 move either way isn't really 50-50, but I still assume the chance of a $3 move up is about the same as a $3 move down.
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Hi optionsgirl,

This depends on the delta of the options. itm options has more delta (positive for call or negative for put) and otm options has less delta. The combination of delta and gamma of the options can estimate how fast you gain and lose money if you only based on movement of the stock excluding consideration of vega and theta.

Chee Yong
 
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