Success in trading stocks a prerequisite for success in trading options?

Cowbow, you wrote a lot of stuff on here so I'm just going to try to sum up my thoughts. Look, you don't know me from a hole in the wall. I realize that. I apologize if my posts seem like they are attacking you, that is the nature of forums I guess. I'm not attacking you and I'm not trying to belittle you. I'm just trying to put your experience in perspective. That is not a good or bad thing. It's just a material fact.

My comments are not all directed at IC. I'm sorry if you thought they were. Our conversation was bleeding into the hypothetical and theoretical and my comments were focused in that direction.

You asked about account value, I kind of assumed a 50k account value with the 10 lot IC. We can use 100k, that's fine. You made the comment that in my example, the 20 to 200 shares would not add up to much money. I will have to disagree. It's not a question as to how much money, but does the profit profile match that of the IC. We all know IC make little to nothing in returns if no leverage is applied. So if we use a hypothetical 100k account and we trade 10 lots on the SPY, your returns are going to be small as well, just as the stock returns are. Do not underestimate how much money you can make with 100 to 200 shares scalps. Keep in mind that once or twice a year will get to that 500 and 1000 share area.

My guess is that with 10 lots on the SPY, you are probably aiming for a 10% annual return. So that's a little less then 1% a month. Let's say 800. You can easily make that 800 a month trading 20 to 200 shares of spy. That's only 40 bucks a day. Your small profit in my example was 20 dollars. But when you get to 200 shares you are making 200 or more a pop.

Look, I'm not trying to tell you this is a great way to trade. If anything, I'm arguing against it. I'm not a mean reversion trader and don't like the style. IC trades are mean reversion trades just as the share equivalent strategy is as well. As I said before, they both should produce the same result except that the stock strategy has an embedded OTM strangle built into it that over time should create a small out performance. The flash crash is a moot point as we can argue 1000 different scenarios where one would be better then the other.

The concept of fair value really had nothing to do with IC's except I was trying to deliver the point condors are simply grouping of other individual options. If we go back to my comments early on in this thread, my assertion was that in order to be a profitable options trader, you need to have an edge somewhere. Either with the underlying instrument or with the volatility of that instrument. And since being long iron condors is always a short volatility trade, the question comes down to two things. You are either right on volatility or you leg in at such great prices that volatility really doesn't matter but that begs the question as to whether your ability to leg in so effectively is being rewarded well enough by simply selling vertical 5 to 10 delta spreads.

The problem with having these discussions on an internet message board is that they can go in too many different directions at the same time for a smooth flowing argument to take place. I live in Chicago, I have this invitation to anyone on this board, if you live in the Chicago area, I'll be more then happy to have this conversation with you in person if you like, drinks on me. Same goes for anyone for that matter. I have met many ET'ers in person and I find the dialogue much more engaging then posting. Regardless if you don't live in the area, I don't post much on these boards anymore as I have fulfilled my lifetime quota already. I randomly respond to these threads now on a lark and make some comments and leave.

I'll say one more time, I'm not trying to attack you or anyone else. I have some experience in this business that might prove useful to you, it might not, but that is all I'm offering. Nothing else. I have been trading options for 14 years. I have been a member of 3 exchanges, worked for several prop firms and I teach this stuff in Chicago to the public. All that and 2.00 will barely get me on a Chicago bus. But it makes for interesting conversation. That's all it is.

Happy holidays.
 
Quote from Maverick74:

Actually I believe he did. I can't speak for the magnitude of the profits but it's been written about all over the web. I believe 2008 was the best year his fund ever had. I should clarify, the fund he has an advisory role with. Much has been made that it's not "his" fund per se. I'm not going to argue over the semantics. Regardless, I believe his ideas are sound.
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Yea, he's made plenty of money, even before his fund - he made a lot of money trading at a variety of banks, notably in '84 and in '87.
 
Quote from Soon2Bgreat:

Yea, he's made plenty of money, even before his fund - he made a lot of money trading at a variety of banks, notably in '84 and in '87.
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He was a local, and AFAIK, has never traded for a bank. He lost money for Paloma in the late 90s, alot of money
 
Mav,

I agree with most of what you're saying here (esp. about needing a vol or directional edge), but there's one part of your strategy comparison that doesn't quite stack up for me, perhaps I've misunderstood. Twice you referenced that the stock strategy could perform better in a black swan type event (specifically 'catching a flyer' and 'having an otm strangle built in').

While you wouldn't catch a flyer with the condor, clearly the embedded OTM strangle caps the max loss. However, I don't see why you think the stock strat has an advantage under such a scenario. You set a profit target at 1 x ATR in the stock strat, so unless a huge gap comes from an overnight move or trading halt, you getting closed out at your limit and do not catch a flyer. Likewise with your stoploss, if there's an overnight move or trading halt, it could just as easily go against you with an unbounded loss. So how does that equate to an advantage for the stock strat? Seems like positive and negative flyers are impossible with the condor, while the potential for positive and negative flyers in the stock strat would net out. What am I missing?
 
Quote from bs2167:

Mav,

I agree with most of what you're saying here (esp. about needing a vol or directional edge), but there's one part of your strategy comparison that doesn't quite stack up for me, perhaps I've misunderstood. Twice you referenced that the stock strategy could perform better in a black swan type event (specifically 'catching a flyer' and 'having an otm strangle built in').

While you wouldn't catch a flyer with the condor, clearly the embedded OTM strangle caps the max loss. However, I don't see why you think the stock strat has an advantage under such a scenario. You set a profit target at 1 x ATR in the stock strat, so unless a huge gap comes from an overnight move or trading halt, you getting closed out at your limit and do not catch a flyer. Likewise with your stoploss, if there's an overnight move or trading halt, it could just as easily go against you with an unbounded loss. So how does that equate to an advantage for the stock strat? Seems like positive and negative flyers are impossible with the condor, while the potential for positive and negative flyers in the stock strat would net out. What am I missing?
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Well, true if one uses hard limits. In the previous posts I discussed actually getting a feel for the market and letting your winners run a little. In the example lets say being short 1k shares at 126.00, one could put in a hard limit for 500 at say 125.00 and hold on to the other 500 buy at market when they wanted to. In this case, with the flash crash happening mid day one could have done really well. Even better had they bought more shares down there. For example, had I only bought 200 out of my 1000 and then I went in and bought more while the market was tanking, you obviously have the potential of a nice winner.

There are all sorts of permutations to this. It was not really my intention to give cowboy an entire working strategy, not that this is one, I was just trying to give an example. Another example could be one could actually just buy the deep OTM strangle and eat the juice and then execute this mean reservation strategy at a larger scale knowing that a flash crash would stop them out being long the OTM puts already.

Yes I know there are trade offs with this and with any strategy and again I'm not endorsing this strategy, I'm simply pointing out another way to look at what an IC really is and what it isn't. It's not a matter of better or worse but understanding the mechanics of trading.

When guys first learn about options it helps one greatly by looking at various synthetic structures that replicate their strategy as it helps them gain an understanding of what they are trying to accomplish as well as other hidden risks that might be embedded in their position.
 
Quote from Maverick74:


OK, on to fair value. Look, I'm of the same opinion as Nassim Taleb who believes options in general are severely under priced. All of them! But there is more to this statement. Over short periods of time and data sets, option values will appear to be over priced. It's a function of the small data set. This is because of the fat tails.

Over long periods of time, option prices resemble nothing even close to being fair. The reason for this is simple. The rare and isolated events that blow options up 100 to 1000 fold simply cannot be factored into the pricing equation. Otherwise there would be no buyers and no liquidity in the market. I actually posted about this many many years ago on here. Options are priced under normal conditions with the caveat emptor warning written below.

The concept of fair value is similar to the concept of god. You are not going to know what it is until it's too late. But all options have realized volatility at the end of any period of time and that we know after that period concludes. Therefore we can look back and see if the implied volatility at that time matched what the actual volatility was. Again, you will find under most circumstances that the realized vol matches the implied vol pretty closely. Except on those rare occurances where it's actually under priced by magnitude of orders.

As Taleb would say, the error is always to the upside, not the downside. In other words, sure in some circumstances the implied vol was 34 when it should have been 32. Nothing to write home about there. But on the upside you see examples where the implied vol was 25 and it should have been 200. As you can see, if one is going to error, they are better off assuming vol is priced too low rather then too high because the payoff for vol being a little too high is minuscule vs vol being too low.
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Surely you meant, "The rare and isolated events that blow options up 100 to 1000 fold simply cannot be factored into the pricing equation. Otherwise there would be no <i>sellers</i> and no liquidity in the market."

If sellers knew the odds of a super crash they could price that into the puts they sell. I still believe that options are fairly priced, in the same sense that bread is fairly priced at the supermarket. When I say that bread is fairly priced I mean that it is unlikely I could get a substantially lower price by going to another store, or by negotiating with grain sellers or the like (when I take into consideration the value of my own time and effort). At the same time the bread is not substantially under priced, in that the farmer, grain distributor, flour maker, bread baker, and retailer are all probably making a fair profit. That does not mean that I might not buy bread some day and a week later a blight wipes out the world wheat crop, sending bread prices up by a factor of ten.

I am not privy to the option pricing models used by market makers (the one thing we can be certain of is that they are not blindly applying Black Scholes). In light of the October 1987 and September - November 2008 crashes I am sure that the market makers are trying assiduously to price in the risk of those far OTM puts, and hedge as best they can against major market moves.

Taleb made a lot of money buying OTM puts in 2008, but had he applied the same strategy throughout the 90s he would have steadily lost money. The fact that sellers of well OTM options usually make money does not prove that options are over priced any more than the fact that option sellers occasionally blow up proves that options are under priced.
 
Quote from Maverick74:

Cowbow, you wrote a lot of stuff on here so I'm just going to try to sum up my thoughts. Look, you don't know me from a hole in the wall. I realize that. I apologize if my posts seem like they are attacking you, that is the nature of forums I guess. I'm not attacking you and I'm not trying to belittle you. I'm just trying to put your experience in perspective. That is not a good or bad thing. It's just a material fact.

My comments are not all directed at IC. I'm sorry if you thought they were. Our conversation was bleeding into the hypothetical and theoretical and my comments were focused in that direction.

You asked about account value, I kind of assumed a 50k account value with the 10 lot IC. We can use 100k, that's fine. You made the comment that in my example, the 20 to 200 shares would not add up to much money. I will have to disagree. It's not a question as to how much money, but does the profit profile match that of the IC. We all know IC make little to nothing in returns if no leverage is applied. So if we use a hypothetical 100k account and we trade 10 lots on the SPY, your returns are going to be small as well, just as the stock returns are. Do not underestimate how much money you can make with 100 to 200 shares scalps. Keep in mind that once or twice a year will get to that 500 and 1000 share area.

My guess is that with 10 lots on the SPY, you are probably aiming for a 10% annual return. So that's a little less then 1% a month. Let's say 800. You can easily make that 800 a month trading 20 to 200 shares of spy. That's only 40 bucks a day. Your small profit in my example was 20 dollars. But when you get to 200 shares you are making 200 or more a pop.

Look, I'm not trying to tell you this is a great way to trade. If anything, I'm arguing against it. I'm not a mean reversion trader and don't like the style. IC trades are mean reversion trades just as the share equivalent strategy is as well. As I said before, they both should produce the same result except that the stock strategy has an embedded OTM strangle built into it that over time should create a small out performance. The flash crash is a moot point as we can argue 1000 different scenarios where one would be better then the other.

The concept of fair value really had nothing to do with IC's except I was trying to deliver the point condors are simply grouping of other individual options. If we go back to my comments early on in this thread, my assertion was that in order to be a profitable options trader, you need to have an edge somewhere. Either with the underlying instrument or with the volatility of that instrument. And since being long iron condors is always a short volatility trade, the question comes down to two things. You are either right on volatility or you leg in at such great prices that volatility really doesn't matter but that begs the question as to whether your ability to leg in so effectively is being rewarded well enough by simply selling vertical 5 to 10 delta spreads.

The problem with having these discussions on an internet message board is that they can go in too many different directions at the same time for a smooth flowing argument to take place. I live in Chicago, I have this invitation to anyone on this board, if you live in the Chicago area, I'll be more then happy to have this conversation with you in person if you like, drinks on me. Same goes for anyone for that matter. I have met many ET'ers in person and I find the dialogue much more engaging then posting. Regardless if you don't live in the area, I don't post much on these boards anymore as I have fulfilled my lifetime quota already. I randomly respond to these threads now on a lark and make some comments and leave.

I'll say one more time, I'm not trying to attack you or anyone else. I have some experience in this business that might prove useful to you, it might not, but that is all I'm offering. Nothing else. I have been trading options for 14 years. I have been a member of 3 exchanges, worked for several prop firms and I teach this stuff in Chicago to the public. All that and 2.00 will barely get me on a Chicago bus. But it makes for interesting conversation. That's all it is.

Happy holidays.
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Thanks for the apology...accepted.

My real issue with scalping vs ICs is the black swan risk. I don't find flash crashes to be moot at all when they could inflict serious damage on an equity position. I'll admit that a trader could potentially get in more scalps in the same time frame as an IC and make more money...but at what risk? I don't see this as an inherent edge as much as a risk/reward trade-off. IMO, the IC trader who can make money through either legging in or out, or by correctly guessing volatility is rewarded not only by the premium from 5 to 10 delta spreads he has sold, but by the risk of a huge loss that he didn't have to worry about. That peace of mind will always cost something.
 
Quote from Soon2Bgreat:

What exactly do you think the purposes of markets are?
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In this context you could say that markets try to put a price on uncertainty. What do you think the purposes of markets are?
 
Quote from rew:

Surely you meant, "The rare and isolated events that blow options up 100 to 1000 fold simply cannot be factored into the pricing equation. Otherwise there would be no <i>sellers</i> and no liquidity in the market."

If sellers knew the odds of a super crash they could price that into the puts they sell. I still believe that options are fairly priced, in the same sense that bread is fairly priced at the supermarket. When I say that bread is fairly priced I mean that it is unlikely I could get a substantially lower price by going to another store, or by negotiating with grain sellers or the like (when I take into consideration the value of my own time and effort). At the same time the bread is not substantially under priced, in that the farmer, grain distributor, flour maker, bread baker, and retailer are all probably making a fair profit. That does not mean that I might not buy bread some day and a week later a blight wipes out the world wheat crop, sending bread prices up by a factor of ten.

I am not privy to the option pricing models used by market makers (the one thing we can be certain of is that they are not blindly applying Black Scholes). In light of the October 1987 and September - November 2008 crashes I am sure that the market makers are trying assiduously to price in the risk of those far OTM puts, and hedge as best they can against major market moves.

Taleb made a lot of money buying OTM puts in 2008, but had he applied the same strategy throughout the 90s he would have steadily lost money. The fact that sellers of well OTM options usually make money does not prove that options are over priced any more than the fact that option sellers occasionally blow up proves that options are under priced.
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Correct. I never stated options are not fairy priced. Again with the limitation of a message board, my posting went off in another area where I was making a broad theoretical statement, that if anything, options are most likely under priced over huge data sets and long periods of time. On a day to day basis I'm of the opinion the vol is amazingly well priced and I don't believe there is really much edge to be had by saying the implied vol is at 33 and should be at 32 so I will sell vol here.

What I might say is if I wanted to be long XYZ and vol looked 100 bp rich, I might be so inclined to structure an option position that expresses my long delta view as well as takes into account the richness of short term vol. We're splitting atoms here though. :)
 
Quote from CloroxCowboy:

Thanks for the apology...accepted.

My real issue with scalping vs ICs is the black swan risk. I don't find flash crashes to be moot at all when they could inflict serious damage on an equity position. I'll admit that a trader could potentially get in more scalps in the same time frame as an IC and make more money...but at what risk? I don't see this as an inherent edge as much as a risk/reward trade-off. IMO, the IC trader who can make money through either legging in or out, or by correctly guessing volatility is rewarded not only by the premium from 5 to 10 delta spreads he has sold, but by the risk of a huge loss that he didn't have to worry about. That peace of mind will always cost something.
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OK, not to beat a dead horse here but I'm not trying to sell you on either strategy. I'm simply trying to illuminate what an IC is, a mean reversion strategy. You can shoot 1000 holes in the stock strategy and I can shoot a 1000 holes in the IC strategy. Neither is better or worse and that was my point.

One more tiny little point here. You keep talking about black swan risk but I can tell you at my prop firm, far more guys have blown out on iron condors then long stock positions. It's not even close. Now, I know you can always trade them really small, but then your profit is going to be minuscule as well. It's a trade off. At the end of the day, the IC is a leveraged bet on a 5 delta spread. That's it. How much you end up making over time will be dictated by the leverage you use. That same leverage will also dictate how big your hits are.

Oh and when I said the flash crash was a moot pt, I meant in comparison to the IC. I really do not believe the IC fares any better in a flash crash then long a small amount of index shares. Just my opinion. I'm often wrong.
 
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