What's wrong with Iron Condors

[Secatu]

Question as a newbie:

Is there a buyer/seller opposite every spread or do market makers use single call/put buyers/sellers to offset?

It seems to me that market makers would not have to automatically offset positions by the exact same position if they can gather single buy/sells to offset. But then again, I don't really understand how market makers work.

Thanks.

 

[galvinlee888]

No. Because if entered randomly, then current market price is the correct price. He is overpaying equal to transaction costs, and you are underselling equal to transaction costs. Without a direction or volatility edge, both of you have a negative expectancy. [/B]

++1

This is precisely the points that I always tell the people in this board, but are constantly being denied and debutted by certain groups that have hidden interest in this board.

None of the IC traders profit in long term ( > 10 years) and they will be extreme lucky if they can only break even - commission and slippage will come back to hunt you eventually as the market is actually price correctly in long term.

 

[newwurldmn]

1. What does "beat the market without taking on significantly greater risk mean?" There are many definitions as to what "the market is" and measures for risk. Is this different from expected value? If not, then name a strategy that would qualify here.

2. If an investor is trading a particular asset without a specific profit motive on that asset and he isn't driven strictly by profit motive on THAT asset then doesn't that potentially create an expected value positive trade for the counterparty?

3. By this standard every trading strategy is expected value negative. Isn't this why most traders do not succeed. What they think is some strategy is really random? The successful ones use their skill to determine when a particular set up isn't random. This applies to all forms of trading and probably investing.

Quote from Cache Landing:

I should've been more clear. There are no papers like that which promote a strategy that beats the market without taking on significantly greater risk.



I made that exact same point. The goal isn't to lose money, it is to purchase peace of mind. Besides that, it is a completely different argument and is distorting the point.



No. Because if entered randomly, then current market price is the correct price. He is overpaying equal to transaction costs, and you are underselling equal to transaction costs. Without a direction or volatility edge, both of you have a negative expectancy.

 

[jb514]

Quote from sle: In any case, there is an economic explanation for why vols are structurally rich. Any seller of convexity will demand compensation for (a) increased dispersion in his returns and (b) for negative correlation of his returns with the general state of the world. You could use fancy math and utility functions to prove it, but the intution behind it is pretty simple.

Can't you just logically conclude that implied vols are going to be generally rich just due to demand from buyers?

 

[jb514]

Quote from galvinlee888:

None of the IC traders profit in long term ( > 10 years) and they will be extreme lucky if they can only break even - commission and slippage will come back to hunt you eventually as the market is actually price correctly in long term.

If you are willing to say "none" of the IC traders profit. Then who does?

 

[sle]

Quote from jb514:

Can't you just logically conclude that implied vols are going to be generally rich just due to demand from buyers?

It is a truism.
Anything in the world that is rich is due to demand from buyers and lack of sellers. Question is why the supply/demand curve for vol looks the way it does.

 

[jb514]

Quote from sle:

Question is why the supply/demand curve for vol looks the way it does.

Excuse my ignorance, but please elaborate on this.

 

[spindr0]

Quote from Cache Landing:

All possible combinations of options carry an inherent negative expectancy that is exactly equal to the sum of commissions and slippage. As much as people will try, this statement is pretty much beyond debate at this point. Anyone trying to disprove that statement is either ignorant regarding the realities of derivatives, or they are willingly spending their time trying to disprove countless other statisticians, much like the physicist who devotes his life to disproving Einstein's relativity.

Consequently, iron condors having four legs, carry a negative expectancy that is roughly 4X larger than a single leg trade in the same underlying.

OK, I get the negative expectancy due to slippage and commissions. But what about diagonalized positions where you're selling volatility (sell near month high IV and buy lower IV of further month)? Isn't it possible for such animals to have positive expectancy?

 

[jb514]

Quote from spindr0:

OK, I get the negative expectancy due to slippage and commissions. But what about diagonalized positions where you're selling volatility (sell near month high IV and buy lower IV of further month)? Isn't it possible for such animals to have positive expectancy?

Does the IV really change based on expiration? I think in order to optimize you would need to sell the current month and buy the next month once after the volatility crush.

 

[sle]

Quote from jb514:
Excuse my ignorance, but please elaborate on this.

Well, I am saying that supply/demand curve for implied volatility is not as elastic with respect to actual realized vol as one would expect. Thats what the risk premium is all about.

Quote from spindr0:
OK, I get the negative expectancy due to slippage and commissions. But what about diagonalized positions where you're selling volatility (sell near month high IV and buy lower IV of further month)? Isn't it possible for such animals to have positive expectancy?

Technically speaking, in an efficient market no derivative trade could have any positive expectancy. So, no matter what combination you would come up with, it would not have positive expectation.

Quote from jb514:
Does the IV really change based on expiration?

Of course it does, depending on the environment, front vol could be significantly different from the back vol. There are, again, a lot of good reasons for it. Term structure of vol, both in terms of time (different vol for different expiries) and in terms of the strikes is a pretty fascinating thing in it's own rite.

Quote from jb514:
I think in order to optimize you would need to sell the current month and buy the next month once after the volatility crush.

Well, in the example described you are selling gamma (convexity at the very front) and hoping to protect yourself with cheaper Vega. So, if the realized volatility comes, you would hope that longer dated implied will increase in some proportionate manner and you would be able to alleviate some of your losses. You don't want to be naked short gamma in a crash, you want to be hedged in some way.

In any case, I am going to sleep so we can continue this tomorrow, God willing.