Writing options for a living

[Choad]

Quote from cnms2:

I guess you stumbled on Murphy's Law. It has perceived negative expectancy and an annoying particularity: if you take the other side of the trade, oops! it applies again. It's sort of like Moebius strip: if you remember it from math (http://mathforum.org/sum95/math_and/moebius/moebius.html) both sides of the strip are one.

Well...perhaps...but the idea, and I'll admit it is not much of one, is to try selling an option, for example a call, (can be to Close too!) at the Ask. This is probably not a strategy unto itself, just as a part of your normal option trading operations.

And if you get an immediate execution but the stock has not moved , then buy a slug of stock (enough so that any losses if the call is short are overcome) and wait a couple minutes because it will be moving up...

Like I said, not much of an idea!

 

[AAAintheBeltway]

Quote from Babak:

Guys, can you pick this apart?

Or is it solid?

Is it that the probability for the two scenarios are not equal? That is to say, there is more of a chance in a change of volatility than a change the same magnitute in the underlying? I'm just guessing this because intuitively I think the chance that the price will go up 30% is much less than the probablity of the vol. going up that much.

I'm sure riskarb, Mav and dummy-v can explain this better, but the hypothetical has a lot of gamma and little vega. Do the same exercise on a call 9 months out that is way OTM and see what the result is. Also, an increase of 30-36 is 20%, not 25.

 

[dummy-variable]

Quote from Babak:

Guys, can you pick this apart?

Or is it solid?

Is it that the probability for the two scenarios are not equal? That is to say, there is more of a chance in a change of volatility than a change the same magnitute in the underlying? I'm just guessing this because intuitively I think the chance that the price will go up 30% is much less than the probability of the vol. going up that much.

this is nonsensical. there is no "flaw" they are just pulling randomly selected scenarios out of thin air to sell whatever it is they're hawking. and as triple A points out they don't even get their math right in the examples. there is no way the ATM option they describe can go up in value in 32 days if IV is the only variable that changes and it only goes to 36%. ( i calculate the call being worth less than 2.60 if the stock stays at $60).

is volatility more likely to move X% than the underlying moving X%? well at 30% vol, a $60 stock has a standard deviation of +/- 5.3 points for a 32 day time frame. so for the underlying to move $15 in 32 days would be a 2.8SD event which has about 0.46 % chance of occurring ( a 200 to 1 shot). even if vol turns out to be 36%, the chance of a 15 point move in that time frame is under 2% (or at best with their parameters it's about a 50 to 1 long shot).

to gauge whether volatility can move up 25% you'd need the "volatility of volatility" to do the same kind of calculation for the probability of IV rising 25% in X days. they don't supply that info to make the analysis meaningful. but my guess is the chances of IV moving from 30% to 36% are much more likely than the underlying going from $60 to $75.

more basically (as again AAA points out) we're talking about comparing extrinsic and intrinsic premium and different risk factors (namely vega and gamma). it really doesn't matter what happens to volatility if an option is 15 points in the money with a month to go. you can see from the example that at $75 the 60 call is almost all intrinsic value. while at $60 the call is obviously all extrinsic premium.

these guys obviously know very little about options and are selling some kind of directional stock picking system. (i did not check their website to verify this). they may be good or bad at that but given the limitations of their knowledge in this pitch i'd be very suspicious of their claims and their abilities.

 

[Profitaker]

Quote from Babak:

They're only pointing out that percentage for percentage, underlying movement has a greater effect on option pricing than does IV movement, in their example.

You've got to come up with some real whacky numbers to get vega risk on a par with gamma risk, e.g.

Underlying 60
Strike 160
Expiry 400 days
IV 100%
Risk free rate 4.75%

In the example above, a 1% IV change has the same effect as a 1% underlying change, on the Calls valuation.

The company are only stating what any option trader is well aware of. But I guess they're after the gullible.

 

[nitro]

Quote from Maverick74:

IV is irrelevant here. IV is only known AFTER the fact....

No,

Realized volatility is known after the fact. IV is always a measure into the future. Once the future becomes the present, IV -> Realized Volatility.

There are some studies (like Soros's Market Reflexivity) that suggest that IV affects Realized Volatility...

Too bad I just noticed this thread after 90 pages, I don't feel like reading it all...

nitro

 

[riskarb]

Quote from nitro:

No,

Realized volatility is known after the fact. IV is always a measure into the future. Once the future becomes the present, IV -> Realized Volatility.

There are some studies (like Soros's Market Reflexivity) that suggest that IV affects Realized Volatility...

Too bad I just noticed this thread after 90 pages, I don't feel like reading it all...

nitro

It's been a long time since I've glanced at the book, but I believe Soros' premise was that IVs rise into known macro-events, and that spot-vols tend to parallel the rise in IV. Like the rise in FX vols into the mid-90's G7 meetings, GBP vols into BOE rate-announcements. It's seen every day in micro-events, earnings releases, etc... To coin the term "reflexivity" is akin to polishing a turd. It's common knowledge to anyone who's traded an option. I agree that using "reflexivity" / "mean-reversion" sounds exotic.

atmIVs are the market's best estimate of future, realized vol over the term-structure represented by the option series in question. Empirically it has[atmIV, not strip vol] been shown to correlate the spot-vols better than recent, realized vols. So who's to argue that IVs shouldn't lead spot and exhibit tight-correlation?

 

[Profitaker]

Quote from riskarb:

Empirically it has[atmIV, not strip vol] been shown to correlate the spot-vols better than recent, realized vols.

Over what time frame ?

I'd be interested to hear of any research ?

 

[riskarb]

Quote from Profitaker:

Over what time frame ?

I'd be interested to hear of any research ?

I don't have the runs in front of me, and although I had access to it, it's not my IP. Data from the recession in the early 90s to date. It's hourly index vols for the atm combo. Since atmIV > spot there was no cause for running the strip-vol numbers, as strips > atmIVs.

 

[Samson77]

When you guys talk about volatility are you talking about the volatility of the option or the underlying?

 

[Maverick74]

Quote from nitro:

No,

Realized volatility is known after the fact. IV is always a measure into the future. Once the future becomes the present, IV -> Realized Volatility.

Nitro, if you read this whole thread, you would know that we have stated just that, including myself, at least a dozen times. This thread is starting to repeat itself.

There are some studies (like Soros's Market Reflexivity) that suggest that IV affects Realized Volatility...

IV is implying what the future realized volatility will be. So it stands to reason that one could think that IV has an effect on realized vol. It's a moot point trying to argue it because you can never know before the fact. All you can do is speculate.


nitro [/B]