What strategy works like selling DOTM naked call?

Quote from Profitaker:

Mav


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.
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Correct. This is my point. What you are really doing is simply trading deltas, not vol!!!!!!!!!!!!!!!!!!!!!!!

And if you are trading deltas, you cannot have edge per se. Unless you feel you have a directional trading system that provides you with "perceived" edge.

That is what I spent hours trying to explain to FA. It's very hard for newbies and even experienced option traders alike to understand this concept. It takes a lot of introspective thought for the light bulb to finally turn on.
 
Mav

I’m not a newbie and I’d like to think I have plenty of introspective thought. No ego here sir, always willing to learn.

I still can’t get my head around your thinking. Persevere, please....

I know you are trading Delta’s. Let me try another angle.... As you say, delta is a function of IV. If the IV is wrong then so is the delta. If you bought the 105 calls for 20 vol the delta maybe 0.15, but if the correct vol is 30 then the delta should be 0.25. So you have a bargain, an edge, an advantage, though not necessarily a profit.

Another way.... if GOOG ATM were trading at 200% vol, what would you do and why? If GOOG ATM were trading at 10% vol, what would you do and why?

I think I know your answers, it’s the “why” I’d be interested in.

TIA.
 
Quote from Profitaker:

I know you are trading Delta’s. Let me try another angle.... As you say, delta is a function of IV. If the IV is wrong then so is the delta. If you bought the 105 calls for 20 vol the delta maybe 0.15, but if the correct vol is 30 then the delta should be 0.25. So you have a bargain, an edge, an advantage, though not necessarily a profit.

No, adding deltas is not creating an edge. That is akin to me saying I think GOOG is a buy here at $500 a share. Instead of buying 100 shares, I'll buy 200 shares and have twice the edge!!! No, it doesn't work that way. The delta of your option has nothing to do with edge. If the delta you are selling is a 30 delta option and it should be a 25 delta option, that does not equate to more edge or any edge at all.

Another way.... if GOOG ATM were trading at 200% vol, what would you do and why? If GOOG ATM were trading at 10% vol, what would you do and why?

I think I know your answers, it’s the “why” I’d be interested in.

TIA.

There is nothing to do in either case based on that information alone if you do not already have a position on. What I mean by that is, say you bought some vol last week at 150% and now you can sell vol at 200% against it, well that is one way you could take advantage of that trade. Or you could sell some of vol at 200% and buy some other vol at 175%. In the lower vol example, you could buy some of that 10% vol and sell some 14% vol somewhere. Just buying vol at 10% in GOOG is not an edge nor is selling it at 200%.
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Profitaker,

perhaps it would help if you think of "edge" as an arb per your original post. In my mind there is little to no difference between a defined edge and an arb. What mav is trying to convey is that there is a difference between a defined edge and a "perceived" edge.

Defined edge will only come from keeping the spread between the options or locking in vols as in conversions/reversals i.e. almost no risk as you arent speculating on anything. This is where the casino/bookie model fits in.

Perceived edge will come from some kind of a directional/vega forecast that has worked for you in the past and has yielded some positive expectancy. Sell overpriced? Buy underpriced? Sure, may work for a while and has a perceived edge per your own results. But is there risk to stop working in the future? Why perceived vs real? I'd say because it isnt guaranteed and it includes taking some greek risk due to some speculation. I personally dont think that just because something has yielded positive expectancy in the past it can be called an advantage or a true edge especially true in the cases where you carry large/unlimited event risk exposure.

My 2 cents.
 
Rally

perhaps it would help if you think of "edge" as an arb per your original post. In my mind there is little to no difference between a defined edge and an arb.
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An edge and an arb are two completely different things. One is a certainty, the other isn't. Rather like comparing chalk and cheese. If Mav is talking arb then I’d agree with him completely. But he isn’t.

Profitable conversions and reversals are arbs, they are not an edge.

If the delta you are selling is a 30 delta option and it should be a 25 delta option, that does not equate to more edge or any edge at all.
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I can’t agree with that.

If you take the delta as (loosely) a probability, then you’d be selling a 30% prob bet when you know the true prob is only 25%. It’s an edge, it has to be.

Somebody help !
 
Quote from Profitaker:


If you take the delta as (loosely) a probability, then you’d be selling a 30% prob bet when you know the true prob is only 25%. It’s an edge, it has to be.

Somebody help !

No, this is another common misnomer. Delta is "loosely" regarded as the probability of an option finishing in the money or not but again, this has been proven mathematically to be incorrect. It's just a way of helping people understand delta better. So no, you are not selling a 30% probability bet.
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Quote from Profitaker:

Rally

An edge and an arb are two completely different things. [/B]
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profitaker,

not in my circles. :) Perhaps we are lost in the definition of the word "edge". The word is loosely used in the trading world(particularly among equity traders) to describe what professional option traders call a "perceived" edge. A true and defined "edge" is an arb to almost all professional options traders i've met. The rest is speculation based on historical data which may or may not work on the next trade you do because you think you have the "edge".

How can you say you have an edge when you dont know for a fact that it will prove to be true on your next trade? Statistics arent an edge in my opinion but that doesnt mean there arent hundreds of hedge funds doing statistical arbs which they call an edge.
 
Quote from Profitaker:

Mav

The hedge ratio (delta- Nd1) and the true probability ("to be called" - Nd2) are so close it's like splitting hairs.
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No, again we are miscommunicating. The hedge ratio cannot be accurate if your earlier statement is also accurate. In other words, if we know for a fact how many shares need to be bought or sold dynamically to replicate a risk free position, there would be no risk!!!!!!!!!!

That's the point. You are saying point blank that the ratio is false hence the reason you think you have an EDGE!!!!!! If you are selling an option that you think has a 25% probability of being ITM and you are getting paid as if it were a 30% bet, one of you is wrong!!!!!!!! LOL.
 
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