What strategy works like selling DOTM naked call?
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I'll never be able to shout louder than Maverick, so I'll end with this rebuttal.
1) There are literally hundreds of papers which attempt to design a superior volatility model. Stochastic volatility, local volatility, and Dupire's universal volatility dramatically outperform.
http://citeseer.ist.psu.edu/mills92large.html
http://www.google.com/url?sa=t&ct=r...DOtbJo7HLHMvN12M=&sig2=6E-lZl-27V9v-uJCVmEdwg
2) There are many probability distribution models which account for fat tails.
http://www.google.com/url?sa=t&ct=r...3fuPLIVh0JZW4sXA=&sig2=0L_IQPaUr4KrmJtruEC-UQ
http://citeseer.ist.psu.edu/386854.html
http://www.google.com/url?sa=t&ct=r...bJsfe4xVB9REdc38=&sig2=mCk1n_CL_-dQZ0CPZGvEew
A few minutes with google on "levy" "variance gamma" "jump diffusion" "stochastic volatility" will reveal dozens of relevant papers. Your searching will also reveal dozens of approaches which have several orders of magnitude better pricing models for equity and index markets.
When convexity biases in Eurodollar swaps were discovered (some 15 years after Eurodollars and swaps first traded), everyone discovered they were pricing things incorrectly. My contention is that a simple brownian motion model with a thrown-in smile does not properly model equity and index behavior. As a result, there are pricing discrepancies which are exploitable. Sometimes on the buy side, sometimes on the sell side.
Take it or leave it.
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just for a record...Personally , I think that Nancy "Cannot_Wink" Pelosi is very attractive for 66 yo nonna of four.
I don't follow your thinking here. If you could "isolate other variables", you wouldn't have an edge, you'd have an arb.Quote from Maverick:
Edge is meaningless if you cannot isolate all other variables
We all know that having an edge doesn't guarantee profits, but that doesn't make it meaningless, surely ?
In options trading, the only way to capture vol is if you both buy AND sell a vol mispricing. If you just sell an overpriced option, all you have is a delta bet, not a vol bet. It's a common misnomer by many newbies that if you just buy options that are cheap or sell options that are expensive, then you are capturing some sort of edge in vol.
Taleb talks about this extensively in his book "dynamic hedging". Only if the position is continually hedged, are you actually capturing that vol.
Let me give an example. Say I'm a MM and a customer sells me 10 Dec 105 calls for .80 with the stock at 100. Let's say these calls have a 40 delta and I'm buying them at a 30 vol which I believe is too cheap. So now I'm long 400 deltas. In order for me to lock in a 30 vol on those calls, I need to sell stock at exactly 100.00. Because the options are only at that vol at that price. If I go to sell stock and I don't get that price, say I sell stock at 99.50 instead. Well, at 99.50, I did not lock in a 30 vol but now I locked in a 33 vol. Well, that's no longer underpriced. I wanted to buy a 30 vol but now I have them at a 33 vol.
What happens if I don't sell any stock? You guessed it, I didn't lock in any vol, I simply took a 400 delta bet. The delta is a function of the vol.
What MM's typically do is if they buy those Dec 105 calls for .80 at a 30 vol, they will look to sell some options they think are overpriced to hedge the deltas and capture the vol. So maybe they ended up selling Dec 110 calls for .35 which are trading at a 33 vol. So they sell enough to be delta neutral. So they bought a 30 vol and sold a 33 vol. THEY captured some edge in vol.
You simply cannot just buy underpriced options or sell over priced options for edge. They teach you this day one of being a MM. This is options pricing 101.
Mav
Thanks for the comprehensive reply.
Determining whatâs options are overpriced and what's underpriced well, thatâs another debate.
Donât follow how (in your example) going long OTM calls followed by shorting stock is âlocking in volâ ? You didnât specify a ratio, but my thinking is that youâll change the long call profile into a straddle or long put, depending on just how much stock you sell ?
Thanks for the comprehensive reply.
Sure, but if the option was overpriced youâd still have an edge. Keep selling overpriced options long enough and over the long run you win. The casino analogy is a good one I think, where they can (and do) take large occasional losses. But because they have an edge, over the long run they win.
Determining whatâs options are overpriced and what's underpriced well, thatâs another debate.
Donât follow how (in your example) going long OTM calls followed by shorting stock is âlocking in volâ ? You didnât specify a ratio, but my thinking is that youâll change the long call profile into a straddle or long put, depending on just how much stock you sell ?
Mav
IVTrader - Agreed.
Logically then, if later in the day the SPX was trading at 1410 and you price the puts at 2, what you really did was sell the 1350 puts for 4 at 1410 which would be 17 vol, which is seriously overpriced ?
IVTrader - Agreed.