When looking at any option strategy, my number crunching shows I will lose money in the long run. Take a simple credit spread where I have a 70 percent chance of success. My max profit is 31...max loss is 69. Using IB with the lowest commissions out there...I take in 29 dollars (31 - 2)($1 per contract with IB). This $2 commission now raises my max loss to $71. If I run a similar trade 100 times, I should win 70 times and collect (29 x 70) or $2030.00. But on my 30 losses, I lose (71 x 30) or $2130.00. One would think just take the other side of the trade....but factoring in the bid/ask differential and commission to reverse the trade....you still lose. I have run this analysis on every conceivable strategy and it always results with a loss.....and I'm getting some of the cheapest commission rates out there. Am I missing something....and how does anyone using other brokers with $5 or even $10 base commissions make money over the long term with these 2 and 4 legged spreads? It seems mathematically impossible to overcome slippage on the bid/ask and commission. Even without slippage and commissions...the probabilities would result in a pure break even proposition wouldn't they?
What am I missing....
- Thread starter rfmd1
- Start date
Just to be clear, IB is not the lowest commission out there, just the lowest retail house without negotiating and only using smart routes. With a high volume account, you can do better at other retail brokers and institutional brokers and receive DMA (Direct Market Access).
Also. how do you calculate your odds of success on a trade?
1245
Also. how do you calculate your odds of success on a trade?
1245
You are pretty close to right... with a few corrections.
1. Every failure is not a complete failure. You have a probability of falling between the strikes which will only be a ''partial failure'. It's easiest to calculate your way but not right. Also you have the option of dropping out of the trade early with a smaller loss if things are not going your way... and of doubling down if things ARE going your way thus raising your win.
2. On most trades taken at random you are probably correct since the MM's mostly price options by probability and they will not buy from you at a premium above what probability dictates, or sell to you lower than probability dictates (mostly). Mostly this pricing is true for short term trades like next expiration. If you do longer and longer term trades the trade becomes more of a directional trade and less a distribution probability trade
3. The MM's and the rest of the retail trade DO read the morning paper everyday. 'Probability' is what is defined by the distribution of past price behavior. But future price distributions are not determined solely by past distributions. Future price distributions are determined by events like earnings surprises or disappointments, future earnings expectations based on economic conditions, competition, world political events etc. etc.
4. Option pricing is a more complex market than just what is willed by the MM's. Traders who have an opinion on direction (or non-direction) will buy and sell at premiums above or below what 'probability' dictates.
So in order to be successful you need to sell options at prices that are higher than the 'real probability' would dictate and buy options lower than the 'real probability' dictates.
'Real probability' is unknown, and actual outcome is determined by evolving events as much or more than by past distributions.
Trading options is thus a bet on direction as is everything else.
1. Every failure is not a complete failure. You have a probability of falling between the strikes which will only be a ''partial failure'. It's easiest to calculate your way but not right. Also you have the option of dropping out of the trade early with a smaller loss if things are not going your way... and of doubling down if things ARE going your way thus raising your win.
2. On most trades taken at random you are probably correct since the MM's mostly price options by probability and they will not buy from you at a premium above what probability dictates, or sell to you lower than probability dictates (mostly). Mostly this pricing is true for short term trades like next expiration. If you do longer and longer term trades the trade becomes more of a directional trade and less a distribution probability trade
3. The MM's and the rest of the retail trade DO read the morning paper everyday. 'Probability' is what is defined by the distribution of past price behavior. But future price distributions are not determined solely by past distributions. Future price distributions are determined by events like earnings surprises or disappointments, future earnings expectations based on economic conditions, competition, world political events etc. etc.
4. Option pricing is a more complex market than just what is willed by the MM's. Traders who have an opinion on direction (or non-direction) will buy and sell at premiums above or below what 'probability' dictates.
So in order to be successful you need to sell options at prices that are higher than the 'real probability' would dictate and buy options lower than the 'real probability' dictates.
'Real probability' is unknown, and actual outcome is determined by evolving events as much or more than by past distributions.
Trading options is thus a bet on direction as is everything else.
"A little learning is a dang'rous thing;
Drink deep, or taste not the Pierian spring:
http://en.wikipedia.org/wiki/Pierian_Spring
Drink deep, or taste not the Pierian spring:
http://en.wikipedia.org/wiki/Pierian_Spring