Time to go vega positive?
- Thread starter Hello_Dollars
- Start date
Maverick:
I read your comments about quants with interest. I am sure there are many examples of quantitative program traders who have screwed up. I'm a mechanical engineer by training. When I work, I have rely on math, and so I do have to confess that bias. I think what happens in finance is that smart people become complacent. Based on what I have read, this surely happened with LTCM for instance. What interests me is the contrast between "the markets" and the casino industry. While I don't have connections in the financial markets, I do have a friend in the gambling busines, and he explains it to me this way: "On average, we maintain just a slight edge over the player. Sometimes it is less than .5%. When we get "whales" in town, we always make sure that they agree to spend a minimum of x hours at the tables. On a one time basis, we sometimes get beat pretty bad, but over the course of the year, the house always makes it back and more". I have to believe that when a quantitative program or individual trader fails, they are either complacent or incompetent. By the way, isn't it interesting that we are hearing about all the problems in the financial industry recently, but we almost never hear news about problems in the casino busines. Used to be the other way around I think.
I read your comments about quants with interest. I am sure there are many examples of quantitative program traders who have screwed up. I'm a mechanical engineer by training. When I work, I have rely on math, and so I do have to confess that bias. I think what happens in finance is that smart people become complacent. Based on what I have read, this surely happened with LTCM for instance. What interests me is the contrast between "the markets" and the casino industry. While I don't have connections in the financial markets, I do have a friend in the gambling busines, and he explains it to me this way: "On average, we maintain just a slight edge over the player. Sometimes it is less than .5%. When we get "whales" in town, we always make sure that they agree to spend a minimum of x hours at the tables. On a one time basis, we sometimes get beat pretty bad, but over the course of the year, the house always makes it back and more". I have to believe that when a quantitative program or individual trader fails, they are either complacent or incompetent. By the way, isn't it interesting that we are hearing about all the problems in the financial industry recently, but we almost never hear news about problems in the casino busines. Used to be the other way around I think.
Well the edge in a casino is defined because they actually create the edge. It's kind of like the edge a broker has for charging you commissions. Or the edge a bookie has for taking 10% of your winnings. This is not the same edge that a quant has. A quant has something called perceived edge. It's not really real. He perceives it to be real. So there is a difference. For example, it's possible that I might have a huge edge on a trade and still lose a fortune. The only true edge that exists is the edge the MM has by earning the spread on a two-sided market and then hedging his risk. Outside of that, edge get's really fuzzy. Some guys think that TA is edge but that is something for another thread.
Like I said before, quants on option trading desks generally create models that allow traders to hedge portfolios more effectively or create arbitrage opportunities through synthetic opportunities. But once you go further out on the timeline, the quants have no edge over you or I or anyone else on this board. Think about it for a second. What is the biggest equation they have to solve? Volatility right? Well what happens to volatility as you go further out. You increase your uncertainty right. This is why vega is so sensitive on back month options. Well, it is almost impossible with any degree of certainty to predict long term volatility. Hell, its almost impossible to predict short term volatility.
So if you are trading options over a long time period you cannot be at the mercy of any so-called quant and the perceived edge he thinks he has. So I say again, don't mind the guys upstairs, they have absolutely no effect on your trading to speak of. The only edge that you need in options trading is for the market to move and to be open. Then your in business.
Maybe.....
(doing my best metooxx impression and trying to keep this thread alive at the same time)
(doing my best metooxx impression and trying to keep this thread alive at the same time)
Quote from Cutten:
As Maverick said, taking a position on volatility is basically a directional punt on the underlying. So if you think the S&P has topped, then by all means load up on vol, and accept that you will most likely lose if the rally continues. Personally I haven't found I can make much money by fighting an entrenched market trend. I'd rather wait for it to end and reverse, and then make my move.
===
With all due respect to PHD s and the spelling checker;
and i do respect them all- that spelling checker need some more discretion when it comes to nicknames.
Long put buyers have made nice $ this month ;
may not be a profitable long term business model.
=============================================
Dont confuse a high probability with infallibility-Daryl Guppy, Australian stock trader.
Quote from murray t turtle:
Quote from Cutten:
As Maverick said, taking a position on volatility is basically a directional punt on the underlying. So if you think the S&P has topped, then by all means load up on vol, and accept that you will most likely lose if the rally continues. Personally I haven't found I can make much money by fighting an entrenched market trend. I'd rather wait for it to end and reverse, and then make my move.
===
With all due respect to PHD s and the spelling checker;
and i do respect them all- that spelling checker need some more discretion when it comes to nicknames.
Long put buyers have made nice $ this month ;
may not be a profitable long term business model.
=============================================
Dont confuse a high probability with infallibility-Daryl Guppy, Australian stock trader.
Here's my two cents on volatility:
First, I don't buy that "volatility is basically a directional punt on the underlying" at least with respect to indices.
My counter-example: S&P 500 and VIX for the three years 1995-97.
12/30/94 SPX=459.27; VIX=13.2
12/31/97 SPX=970.84; VIX=24.01
A graphical view clearly shows sustained uptrends for both measures during this period.
Similarly one can find periods (albeit shorter ones) where SPX falls while VIX is flat or erodes.
Instead, I prefer to view volatility as a measure of uncertainty (which translates into the emotions of fear on the downside and greed on the upside). So while most of the time vol will indeed move inversely to the underlying, sometimes it won't. I.e., it is possible that share prices rise, investors don't understand why, but in any case don't want to be left behind, AKA "irrational exuberance."
Second, I do not believe that the market is efficient with respect to volatility. I do believe that it is efficient with respect to equity prices for those of us without inside information. That is, TA and FA is bunk. This is not to say that the market is always right; it can be efficiently wrong. It's just to say that with respect to equity price levels, one cannot legally find abnormally positive risk-adjusted returns over a sustained period. Or said another way, trading stocks to beat the market is a zero-sum game.
Not so with volatility or price uncertainty. Investors buy options for insurance -- against real downside costs or upside opportunity costs. This creates a positive sum game and enables options sellers to earn returns that indeed can and do exceed market-average returns.
I could not disagree with this statement more strongly, and I find it contradictory to say volatility can be mispriced by the "market" but "valuations" cannot. There is no logical reason to assume that the aggregrate market participants which is "the market" somehow consistently gets pricing volatility wrong but somehow prices equity correctly.
Regarding TA. Originally, way back when, I was purely into fundamental analysis. Eventually realized it was only part of the picture and in the short-term, 1-6 months, TA predominates. In my view, TA reduces to 3 things:
1. Human psychology
2. Stocks TREND either up or down
3. Support and resistance levels exist and stocks trend until they hit a support and resistance level and either break through it or are rebuffed.
2 & 3 exist because of 1. Frankly, I don't see how it is humanly possible to study numerous charts over time and not conclude that stocks do indeed trend and/or that particular stocks have tendencies to bounce off of particular price levels or moving average lines.
Regarding FA. I'm not quite sure what it means to price a security "efficiently wrong". That seems to me to be a pure oxymoron. Theoretically, a stock is priced on future cash flows and the growth in those future cash flows. It is a very simple exercise to reverse engineer the current stock price into a <b>market implied growth rate </b>. One can then determine whether that market implied growth rate is absurdly high, reasonable, or absurdly low.
Take tech stocks in 99-00. The market implied growth rates at that time were for 50%+ growth over decades. No company in the history of capitalism has sustained growth rates like that. Obviously, the market had INEFFICIENTLY priced these stocks at that time due to GREED. On the flip side, in Oct 2003, there were many tech companies selling for LESS THAN THE CASH ON THEIR BALANCE SHEETS. Many of those names are up triple digits in %.
Just as fear and greed manifest themselves in option volatility levels, they manifest themselves in fundamental valuation levels.
Thanks for the reply. I'm always looking for pushback to my idiosyncratic views.
Efficiency does not mean "not-mis-priced" the way I'm using the term. Rather it means that typical investors, on average, will not beat the market.
Let's take as a representative body of typical investors....how about mutual fund managers? I bet you will agree that they did not out perform the market (proxy = SPX) during the 1999-00 period you reference. Indeed, I believe the data show they tracked the market, or trailed it slightly, on average. So the market was efficient, but in retrospect clearly wrong. So far, we've just taken the proverbial random walk down wall street.
With respect to volatility, the point is not that it is mis-priced but that there is room for options sellers to net positive because options buyers are willing to net negative as they buy their insurance. There is a service component built into the notion of an option -- an exchange of value for risk assumption -- that doesn't exist in a straight equity trade. Equity zero sum; options positive sum.
By the way, this does not mean that there aren't more losers than winners in options trading nor that long options trades are inherently losers. My pedestrian point is that I'm glad that some options buyers are perfectly happy to see their options expire worthless even though they would have been financially better of in hindsight if they never had made they trade. (Sorta like being glad to have health insurance even though you didn't get sick.) Otherwise I'd have no better than a random shot of generating income and would have to get a real job.
Any comment on my first point -- that being long or short vol is not always a directional punt?
