...By any chance,do you have any papers/references that would indicate the theta for DOTM options is innacurate via BS and is less than what the model indicates??
Not that I'm aware of.
I don’t know who is Ron Bertino (should I?) but if someone can point me out to a source explaining “false theta” I’m happy to hear from him.
PS of course, you know the decay of DOTM is very different (almost linear even in the last days before expiration) than at ATM, but it’s still a decay, no free lunches here….
Buying gamma, I paid for it with theta.
Yes, there a direct relationship.
Just keep in mind the joint jpeg and you’ll be immune from the fables of some serial options sellers who claim to “maximize the theta while minimizing the gamma exposure”.
If I don't have to pay theta, it means I could get a risk free return? If so it would be arbitraged away quickly.
No, according to the B&S framework, you get the risk free return if you hedge away all risk (gamma, vega, theta risk etc…), measured by the greeks.
It’s just theory, there no reason to cover all the risk… no risk no opportunity!
But if someone knows how to get some freebies on theta, please let me know… I’m all in!
I thought to buy tail risk protection, I buy far puts and sell near puts. You said the opposite?
Well, Weeklies are expensive, so people like to sell. But they are expensive for a reason.
Maybe you know LJM, they were some of the oldest professional option sellers on the market. They blow up in just one night, on Feb 2018 (Volmaggeddon), because they were short weeklies, and unable to stand the burden (even with their supposing professional, automated, continuous hedging)
Also, people like to buy FAR because these FAR options have less theta. Problem is …. by now you already know….. if you have less theta, you also don’t have much gamma.
Moreover, FAR options have the biggest VEGA but…. IV for a distant expiration move much less than the first delivery, so this VEGA doesn’t protect you when you are short of weeklies, and the VEGA of the short weeklies blows up in one’s face.
Formally speaking, as Taleb, (once again) explained, VEGA is not additive on different expiration cycles, which means you cannot algebraically sum up VEGA SHORT DATED with VEGA LONG DATED (Taleb also proposes a correction factor, but also his solution is just a roughly approximation).
The big boys (e.g Susquehanna, Wolverine etc..) treat this matter as strictly confidential , and there’s not a set of rules and procedures commonly accepted.
And how do I know I am paying minimum cost for my tail protection?
Well, we have benchmarks.
Artemis Vega Fund has an history going back to 2012 (if I remember well) and Chris Cole sailed also the 2008 crisis. Performance data are on Eurekahedge database (but on a subscription basis).
The naïve way to get tail risk protection is to buy X% of VXX for every Y% of equity. This comes at a cost (negative carry of VXX) but is a passive procedure. So you expect an active manager (to which you pay fees) to be much more efficient in providing the same or better level of protection.
