No, apart from the losses in their highly leveraged fixed income "arb" portfolio, LTCM also lost quite a lot of money on options. AFAIK, their problems in that space resulted from them foolishly and vigorously denying that options markets could exhibit a smile. It was a typical case of academic hubris. That's the bit, I believe, that OddTrader may be referring to.
The best options strategies
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I think they were short a ton of SPX variance and the whole street knew it.
Yes, the outcome is different in terms of P&L variance. An unhedged ATM call option is just a ramp payoff to the upside. You will lose the premium paid or breakeven the majority of the time (say 82% of the time). But when you get a hit (the other 18% of the time), it's significantly bigger. The weighted average comes out to the original expected P&L [(Actual-Implied)*Vega]. A dynamically hedged call option will result in the same expectation, but a different variance profile. Hedging will make both your losses and your wins smaller, shrinking the tails of your P&L distribution. In the limit (continuous hedging), the P&L will converge to the expectation with 0 variance.
Yes. The contracts must be mispriced. It all starts with price.
When actual = implied, the expected P&L = rf rate.
The actual volatility is forward looking. If I buy a 30 day option right now, I need to hedge with the volatility that will be realized over the next 30 days. You will only know what actual volatility was at expiry. So you have to have some type of vol forecast for your hedging and/or spread off risk with other options.
This is a really good, concise explanation of edge (realized less implied)*vega, and the convergence to expectancy on hedge frequency. Think about the opportunity cost of capital; commissions; missed hedges; microstructure, gaps...
Weren't they primarily in var swaps? Did they short puts outright as well?
Longthewings, newwurldmn, Martinhoul, destriero, botpro ...
Thanks for the insightful responses. They partially explained why I was not getting good outcome with covered calls, covered puts, calendar... (did worst than my B&H portfolio).
I did well with long calls though, because the general market was going up in 2013 and 2014, somewhat OK in 2015, not because I had some magic formula.
But I got killed in 2016 with long calls.
Thanks for the insightful responses. They partially explained why I was not getting good outcome with covered calls, covered puts, calendar... (did worst than my B&H portfolio).
I did well with long calls though, because the general market was going up in 2013 and 2014, somewhat OK in 2015, not because I had some magic formula.
But I got killed in 2016 with long calls.Yep, they were involved big time in Europe... When I say "involved" I mean that it was rather comically large and misguided at times from all the stories I heard. Maybe it was small fry relative to all the other stuff, but I extrapolate from that.
Hmm. are you serious with these questions? Because HV can easily be calculated from the historical prices of the underlying.
And from the market premium one can calc the IV, together with delta and many others...
So, I don't get your point here.
What? You must be joking! Vola calc and calc of all the greeks is the simplest to do.
Really, I think you must mean someone else but me, eventhough your above reply was made quoting my posting.
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If this imples that hedging is useful only when the entry is done with a mispriced price, then I must say it's complete utter BS.
Entry price, be it fair or mispriced, is irrelevant for hedging, as the delta is the main player, with optionally some of the other option greeks...
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- What is a mis-priced option?
- What is a fair-priced option?
