Quote from comintel:
If option premiums were indeed systematically overpriced (as many here assert also), shouldn't it work?
That is why he tested it, just as a base case, to see if option premiums really are overpriced to the extent that one could make money on that ground alone.
Isn't that what many of the educators claim? I have watched their videos and heard advice like "Trade iron condors every month until you are good at them."
Granted, many advocate ongoing position adjustments but I (and the author of the e-book) are very dubious about those also.
The author of the e-book goes on to test the effect of adding volatility-screens and other additions and finds that when these are added to the base case, then there are some profitable strategies.
I am mainly trying to pin down the issue of whether options (especially index puts) are or are not systematically overpriced. Some people here say they are, without providing much evidence to back up their assertion.
Even assuming that vol is overpriced, with naked vol selling you are still exposing yourself to a huge DD if a shock event takes the indexes down in the first days/weeks of your program.
You are essentially getting exposed right off the bat to equity-like DD when the entire purpose of selling options was to get as low a beta as possible (less correlation to the stock market).
In that case why not just go long the SPX will large stops (martingale). You will get many winner with the occasional stop getting triggered. In fact, this strategy's equity curve would look very similar to a naked selling strategy (ie. not good)
So you see, even if there is an advantage over time due to overpriced premium collection, that advantage will not help you if the market tanks right in the beginning. In other words, you would not have built up a large enough buffer of collected premium to withstand the drawdown.
So if you are not selling condors and remain naked, you have the same problem that any other trading system has:
the distribution of losses is random. Yes, the market does have mean reverting tendencies, but you cannot time exactly when or how close together market crashes can occur.
So the soundness of the strategy does not hinge on whether vol is overpriced since you have not collected any at the start of your trading.
If the market crashes are timed in a way that they occur wide appart, you are good, if not, you lose.
If you are aiming for the market average of 10%/year you will probably do ok over time. But targeting anything above 15% gets tricky. Although I have some reservation about the liquidity that is available when it is actually needed. Tail risk is related to liquidity risk since it causes bids/asks to widen. Tail risk these days is indeed higher than it has ever been.
