Where to find edge in option trading ?

[SmithTheTrader]

We all know that you need an edge in order to obtain alpha in your trading, or else eventually you will loss in long term due to the commision and slippage.

Money management is important as it can prevent any disaster but you still need edge to gain a positive expectancy in long run

In option trading, in order to success in long term you need to know either (or better if you know both) the future of:

1) The direction of the underlying (up, down or sideway) or
2) Volatility (up, down or sideway)
If you know the price movement or volatily for future, you can then design your strategies to capture the move (up, down or sideway) and profit from them..

But the question is how you know the price movement or volatility in future ? Some claim they can do it by some proprietary knowledge in technical or fundemental analysis, ..but how true are those claim ?

I hope those traders in this board that already profit for so many years can answer this question, I know this is a sensitive one as it is aka going to coca-cola and ask for their recipe, ..

 

[u21c3f6]

Quote from SmithTheTrader:

We all know that you need an edge in order to obtain alpha in your trading, or else eventually you will loss in long term due to the commision and slippage.

Money management is important as it can prevent any disaster but you still need edge to gain a positive expectancy in long run

Agreed, you need an edge and money management. I define edge as a positive expection of a series of like "investments". I define money management as knowing the proper size (% of capital) compared to your edge (basically the concept of Kelly).

Quote from SmithTheTrader:

In option trading, in order to success in long term you need to know either (or better if you know both) the future of:

1) The direction of the underlying (up, down or sideway) or
2) Volatility (up, down or sideway)
If you know the price movement or volatily for future, you can then design your strategies to capture the move (up, down or sideway) and profit from them..

But the question is how you know the price movement or volatility in future ? Some claim this can be achieved by technical or fundemental analysis, ..but how true are those claim ?

The above would certainly be very helpful, but not the only way to approach finding an edge and success. In fact, if one could "know" the direction of the underlying for a certainty, there would be no need for a "system". That fact that one cannot know for a certainty now means that an edge must be found to not only cover commission and slippage but also the % of time that your "investments" are wrong and still show an acceptable % of positive expectation.

When I discuss what I do I usually discuss it in sportsbetting terms, 1. because thats how I see it and 2. because I think it conveys the concept better without confusing the subject with all the additional "financial" terms used for "investments". The options market functions exactly the same way as a live sportsbetting market. I developed my edge for both of those markets from the fact, (drum roll), they are both priced today (now) based on "expiration" expectations.

There's the "formula" that I use. No charge for the Coca Cola.

There is plenty more to write but I will stop for now. I have "investments" on the NY-Philly game! :eek:

 

[SmithTheTrader]

Quote from u21c3f6:

Agreed, you need an edge and money management. I define edge as a positive expection of a series of like "investments". I define money management as knowing the proper size (% of capital) compared to your edge (basically the concept of Kelly).





The above would certainly be very helpful, but not the only way to approach finding an edge and success. In fact, if one could "know" the direction of the underlying for a certainty, there would be no need for a "system". That fact that one cannot know for a certainty now means that an edge must be found to not only cover commission and slippage but also the % of time that your "investments" are wrong and still show an acceptable % of positive expectation.

When I discuss what I do I usually discuss it in sportsbetting terms, 1. because thats how I see it and 2. because I think it conveys the concept better without confusing the subject with all the additional "financial" terms used for "investments". The options market functions exactly the same way as a live sportsbetting market. I developed my edge for both of those markets from the fact, (drum roll), they are both priced today (now) based on "expiration" expectations.

There's the "formula" that I use. No charge for the Coca Cola.

There is plenty more to write but I will stop for now. I have "investments" on the NY-Philly game! :eek:

u21c3f6 - Thanks , this is precisely the type of answer i hope i can get from here.

The interesting part is that so far you are the only one that replymy post although quite a lot of people view this thread.. may be it is far more easy to answer the question related to with all kind of options theories and strategies (like greeks, strategies setup, position sizing, risk management..) rather than the "heart" and all the reason for trading - how to find edge..

 

[MTE]

Quote from SmithTheTrader:

u21c3f6 - Thanks , this is precisely the type of answer i hope i can get from here.

The interesting part is that so far you are the only one that replymy post although quite a lot of people view this thread.. may be it is far more easy to answer the question related to with all kind of options theories and strategies (like greeks, strategies setup, position sizing, risk management..) rather than the "heart" and all the reason for trading - how to find edge..

Of course it's easier to answer those questions than "how to find an edge" as there's no set route you need to take to find it.

 

[dagnyt]

Quote from SmithTheTrader:

The interesting part is that so far you are the only one that reply my post although quite a lot of people view this thread..

Speaking for myself, I don't agree with your original premise.

You do not <i>need</i> alpha. If you can find it, that's great, but you can prosper without it.

My edge is my experience. My edge is my ability to limit the chances of getting hurt by a large market move. Profits are plentiful. that's not the problem. The problem is preventing large losses and a disciplined, experienced trader can do that successfully.

Further edge comes from not selling option spreads that are undervalued. I don't just buy iron condors for the thrill of owning them. I'm a premium seller. I do not have any need to know in which direction the underlying stock or index is going to move.

I take a position based on the expectation that the underlying will not move past certain prices - one higher and one lower.

I don't have to know the future volatility of the underlying, but I do have to make a reasonable estimate so that I can select my strike prices. Because the future is unknowable, I cannot predict how far the underlying will move. Sometimes my iron condors behave beautifully and simply move towards zero. At other times, proper risk management becomes essential.

I do not hold positions until they expire. I do not have any need to wring every last nickel from a trade. What I am looking for is to find an underlying that does not make one-directional moves that are either too large or to rapid.

That is NOT alpha.

When I manage risk by buying an appropriate number of iron condors and by not allowing any position to result in a large loss, I prosper. When the markets are too volatile and the moves are huge, unless I adopt other risk management tools (and I do - I buy strangles) I don't prosper.

But nowhere am I seeking alpha.

Mark

 

[SmithTheTrader]

Mark,

Thanks for the insight response.

A quick question - strangle cost money (premium, commison and slippage) especially when the volatility is so high at the moment - doesn't it make sense instead of getting the insurance, it is better to reduce the expose such as reducing the number of positions ?

Another way is to buy a vertical (on both side) as an insurance, as vertical reduce your expose to the crazy premium due to the high volatility at the moment, although you have to tade off with extra risk in the lower delta/gamma for vertical.

 

[MAESTRO]

Quote from MTE:

Of course it's easier to answer those questions than "how to find an edge" as there's no set route you need to take to find it.

Exactly. Option trading is like a chess game; it has unlimited amount of winning strategies and you choose one that is most appropriate for your current opponent (i.e. market conditions). There is no fixed strategy, however, that will guarantee you success. You need to adopt your strategies based on current market volatility, option premiums, premium distribution etc. It is waaaaay more complex than trading the underlying and only very few traders are fit enough to trade options. It is a true elite activity where your decision making skill needs to be multidimensional.

 

[dagnyt]

Quote from SmithTheTrader:

Mark,

Thanks for the insight response.

A quick question - strangle cost money (premium, commison and slippage) especially when the volatility is so high at the moment - doesn't it make sense instead of getting the insurance, it is better to reduce the expose such as reducing the number of positions ?

There's more than one way to do something good for your portfolio.

Yes, reducing size is a great method for reducing risk - and I'm doing that now. I have not bought any strangles recently, but it's a method I've used in the past.

Another way is to buy a vertical (on both side) as an insurance, as vertical reduce your expose to the crazy premium due to the high volatility at the moment, although you have to tade off with extra risk in the lower delta/gamma for vertical.

Yes, buying vertical spreads is an alternative for reducing risk. Buying a put and call vertical is merely selling an iron condor, but regardless of the terms used to describe the trade, it's effective. But as you stated, the protection is limited.

Mark

 

[cfelicio]

Quote from MAESTRO:

Exactly. Option trading is like a chess game; it has unlimited amount of winning strategies and you choose one that is most appropriate for your current opponent (i.e. market conditions). There is no fixed strategy, however, that will guarantee you success. You need to adopt your strategies based on current market volatility, option premiums, premium distribution etc. It is waaaaay more complex than trading the underlying and only very few traders are fit enough to trade options. It is a true elite activity where your decision making skill needs to be multidimensional.

and that's the beauty of it

but at the same time it's easier to the market give you a checkmate with options, so it's a treacherous game, with leverage being your silent killer attacking you when you least expect... so play small