Writing options for a living

[Lucrum]

Quote from torontoman:
Can this be done? Has anyone tried it? Any comments?

Back in the early 90's I blew out my account twice with naked short options positions. And that was using an entry based on the underlying that believe it or not worked 97% of the time. Now just because it didn't work for me certainly doesn't mean it can't be a viable strategy.
But as others have pointed out, as with all trading, you'll need to be properly capitalized/diversified(I was not) and disciplined enough(I was not) to get out/hedge (if you can)when it becomes obvious the trade isn't working.
I'm only hanging my dirty laundry here for all to see to show that the warnings about the risks of this stategy that others have mentioned are in fact very real.

 

[Babak]

Notice that their performance is getting crushed in 2005 (so far):

http://www.ansbacherusa.com/perform_ansbacher.htm

At this rate, they'll probably make 10% (+/-2%). Could it be because Wall Street has brought to market over $6 Billion closed end funds which are devoted to covered call writing?

More supply = lower price

 

[just21]

We're weeks away from IPE options from IB. Volatility is much higher in energy than stock indexes.

 

[kalashnicac]

The vols may revert to mean, but they may also trend against you. Not to quibble, but it's not a matter of edge.

I agree. How about if you plan every strategy so that if vol goes against you, you will not be forced to close your position.

Example : the extreme IV levels of a given index are 8% and 50% (spike) over the entire lifespan of that index. The mean is 15%.

Let's say IV is at 30%. You decide to go short vega. But in your trade plan, your account can suffer a spike at 50 without any margin call, without having to exit. Same idea when trading a long vega position.

Of course some vega bets will be losers and others winners, but wouldn't there be some kind of "structural" edge in the long run?

How about that?

Another little question (sorry if it's naive) : a short gamma-short vega position always expires with 0 volatility, right?

BTW, thanks for all the comments, Riskarb

 

[riskarb]

Quote from kalashnicac:

I agree. How about if you plan every strategy so that if vol goes against you, you will not be forced to close your position.

Example : the extreme IV levels of a given index are 8% and 50% (spike) over the entire lifespan of that index. The mean is 15%.

Let's say IV is at 30%. You decide to go short vega. But in your trade plan, your account can suffer a spike at 50 without any margin call, without having to exit. Same idea when trading a long vega position.

Of course some vega bets will be losers and others winners, but wouldn't there be some kind of "structural" edge in the long run?

How about that?

Another little question (sorry if it's naive) : a short gamma-short vega position always expires with 0 volatility, right?

BTW, thanks for all the comments, Riskarb

Absolutely. Money management was what I was trying to emphasize in my first post on this thread. Trade within your limits.

Yeah, short or long gamma/vega expires at zero-exposure. YW

 

[kalashnicac]

Yeah, short or long gamma/vega expires at zero-exposure

Which means that if there's a spike in IV, there is no need to panic if you are vega short and your risk under control, because eventually IV will deflate...? Sounds rather reassuring for delta hedged option writers/credit spread traders.
Correct me if I'm wrong but this also means that the best moment to go gamma-vega short and selling options is...well...during market crashes (IV spikes). Another illustration of how trading is counter-intuitive I suppose.

 

[Maverick74]

Quote from kalashnicac:

Which means that if there's a spike in IV, there is no need to panic if you are vega short and your risk under control, because eventually IV will deflate...? Sounds rather reassuring for delta hedged option writers/credit spread traders.
Correct me if I'm wrong but this also means that the best moment to go gamma-vega short and selling options is...well...during market crashes (IV spikes). Another illustration of how trading is counter-intuitive I suppose.

Let me jump in here. I think you are misunderstanding a few important concepts here. One, a spike in vega is not your concern. It's the followup with the spike in spot volty that is your concern. Vega does not just disappear! Implied volty becomes realized volty. You can't just sell volty spikes. Good lord. LOL.

You need to take some time and do a careful study on spot volty and implied volty. When implied volty rises, it's usually foreshadowing a spike in actual volty. This is what is going to hurt you! Not the temporary loss in vega.

Selling high volty is not an edge. You need to understand what edge is. When you sell high volty, the MM is buying it from you. HE is the one that has the edge, not you! Mean reversion does not equate to theoretical edge. Selling high volty usually is a recipe for disaster because you are actually selling INTO the event that is going to create ACTUAL volty! I'm not trying to be condescending here, but take some time to learn the difference.

Yes, at expiration implieds go to zero. However, what that actually means, is that at expiration, implied volty becomes realized volty. If you sell an Aug 50 call for .50 at a 45 volty. At expiration, the volty on that call is zero, however, the call might be worth 8 pts!!!!!!!! Not much of a consolation to the naked call seller. LOL.

 

[kalashnicac]

Ah yes I see what you mean Mav. Got a bit caught up in the greeks without having tried to understand what they stand for...

Selling high volty usually is a recipe for disaster because you are actually selling INTO the event that is going to create ACTUAL volty! I'm not trying to be condescending here, but take some time to learn the difference.

Fair enough, but what if the event is unexpected (terrorist attack, bubble explosion). Then the IV rises AFTER the event and you can go short vega on high IV levels.
Ok you might say : IV goes up because people are expecting further disaster. I'd say it goes up because fund managers, who have the obligation of limiting risk exposure, are desperate for puts. Not that they are irrationnal : they might be willing to buy expensive options at high IV levels just so they can comply with their risk management obligations; it doesn't necessarily mean they are expecting further disaster.
The individual option player does not however have these issues as he is responsible for his own money.

Yes, at expiration implieds go to zero. However, what that actually means, is that at expiration, implied volty becomes realized volty. If you sell an Aug 50 call for .50 at a 45 volty. At expiration, the volty on that call is zero, however, the call might be worth 8 pts!!!!!!!! Not much of a consolation to the naked call seller. LOL.

Yes but I was thinking of an option trader who would keep his position delta-hedged...

I'm not trying to be condescending here, but take some time to learn the difference.

No problem, I'm just an option newbie trying to learn a few things, so that when I do eventually blow up my account I will at least know why.

 

[Maverick74]

Quote from kalashnicac:

Fair enough, but what if the event is unexpected (terrorist attack, bubble explosion). Then the IV rises AFTER the event and you can go short vega on high IV levels.
Ok you might say : IV goes up because people are expecting further disaster. I'd say it goes up because fund managers, who have the obligation of limiting risk exposure, are desperate for puts.

When stock markets selloff, IV's do not runup near as much as you think they do. They tend to spike at the beginning of the selloff and then come in hard during the middle to end of the selloff. It's very tough. If you sell on that early spike, you are going to be selling into what is probably just the beginning of the big move. If you wait till everything calms down, the premo will be crushed by then. IOW, there is no free lunch. Guys that sell premo into a hard selloff are really making a long delta bet with the premo being added as a kicker.


Yes but I was thinking of an option trader who would keep his position delta-hedged...

No such thing with dynamic hedging. If you are short gamma, your deltas are only hedged at the moment the hedge is put on. They become unhedged the second the spot moves a tick.

 

[kalashnicac]

Ok got your point.

No such thing with dynamic hedging. If you are short gamma, your deltas are only hedged at the moment the hedge is put on. They become unhedged the second the spot moves a tick.

I am aware dynamic hedging comes at a cost, sometimes to the extent that it wipes out the whole profit potentiel of an option trade. But "partial" delta hedging can reduce risk. You could for instance leave the position breathe a bit instead of adjusting delta every second. Just making sure the position doesn't get too directionnal (one could try to keep delta under a particular number, say 30) seems a reasonable way to avoid the big losses.

With "loose" (as opposed to tight) delta hedging, you limit your risk and who knows you can even make money hedging.