Writing options for a living

[Profitaker]

Quote from riskarb:

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.

I know ATM IV is where it's at, so had already gathered that any research would focus on ATM IV rather than the smile further out IV. The only credible research I'd seen was contained in a book "The options edge", but I'd be interested in more.

Don't agree that underlying IV will influence spot volatility (did Soro's really say that ???). Partly because of the relative market size (derivative market is always smaller) would make it extremely difficult for the tail to wag the dog, and secondly why would any trader with an options position wage money to generate a higher volatility in the underlying market ?

 

[Profitaker]

Quote from Samson77:

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

It could be either, but it's normally made clear in the post.

 

[riskarb]

Quote from Profitaker:

Don't agree that underlying IV will influence spot volatility (did Soro's really say that ???). Partly because of the relative market size (derivative market is always smaller) would make it extremely difficult for the tail to wag the dog, and secondly why would any trader with an options position wage money to generate a higher volatility in the underlying market ?

I am relying on Nitro's reference. I agree; I was making the case for correlation, not influence.

 

[torontoman]

Quote from palawan:

i think what you're saying here is that you can collect those deep out-of-the-money premiums because there's no way the underlying will go there? based on 3 or more standard deviations calculated based on price movement per day, per week, per month, etc.?

http://www.gladwell.com/2002/2002_04_29_a_blowingup.htm

from personal experience:

someone sold (or maybe it was just an MM who turned around and hedged it right away or maybe someone who owned 700 shares+) 7 CME Sept 260 calls back on Apr 28 when the stock was at around low 190's. easy money... 1.5 each call. $1000 for sitting tight for 5 months and knowing that there is no way the CME stock can move 70 points up. i've sold the calls already (when the stock was much less than where it is now).

funny anecdote was that i told a co-worker about it a week after i put the position and he wasn't able to control his reactionary laugh. he wasn't trying to be mean, but come on, he couldn't imagine CME moving 70 points up in five months. by the way, he owned 100 (or 200) shares of CME when it was around 220 and then it backed down to 170... i think he sold for a loss around 180.

so, when you say "you just have to know where it will not go", i'll have to say back to you that i don't know where it will not go. apparently, victor niederhoffer didn't either. twice.

Good Luck.

Great post, Palawan.

But then how about selling options that have never had a terrible event or balck swans. For example S&P calls, Crude oil puts, natural gas puts, silver puts. What can cause these securities to experience a terrible event or black swans as they call it?

 

[palawan]

Quote from torontoman:

Great post, Palawan.

But then how about selling options that have never had a terrible event or balck swans. For example S&P calls, Crude oil puts, natural gas puts, silver puts. What can cause these securities to experience a terrible event or black swans as they call it?

Thanks, Torontoman.

the problem with black-swan events is that the very characteristic of it is that it cannot be predicted or imagined until it has happened.

S&P calls? how about bush being successuful in privatizing SS? can you imagine how the markets would react and how much money could suddenly go to the S&P index which is the most trusted out there

silver puts? i have a market wizards book (the last one of the three, i think) that mentioned in one of the interviews when silver went to $50/ounce only to crash to $5/ounce in a short time.

crude oil puts? i might be a buyer of one of those DOTM options i have an email (which i ran into by accident a few weeks ago) where i mentioned to a friend of mine (who's a casual "investor" in the markets) that i wouldn't put a position until oil has gone back down to below $40/barrel. that was a year ago. i have to laugh at that now... but, if i thought a year ago that oil should be below $40, it's not impossible that it can get there.

taleb may be using a model where he can predict it, but he's got so much resources and brain-power at his disposal. if you have a chance, you should read his book "fooled by randomness". you may not become a fan, but i think he'll make you think and imagine. he's not very popular with the investment community because he has even questioned the "greatness" of the great ones in wall street as possibly a result of survivorship bias.

Good Trading.

 

[hedgeyourbets]

The following is a very misleading statement:

"While there are certainly many viable options-buying strategies available to traders, options expiration data I obtained from the CME covering a three-year period suggests that buyers are fighting against the odds. Based on data obtained from the CME, I analyzed five major CME option markets - the S&P 500, eurodollars, Japanese yen, live cattle and Nasdaq 100 - and discovered that three out of every four options expired worthless. In fact, of put options alone, 82.6% expired worthless for these five markets."

Not all of the 82.6% would expire worthless... Some of those options would be closed out prior to expiration... Those kind of statistical studies only look at the open interest vs. exercised...
(Source: CBOE)

 

[CalPumper]

Quote from Maverick74:

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.

Agreed. All this talk of trying to trade IV is interesting, and perhaps it worked in the past, but I believe that the markets have become effecient enough in the last few years to render a vega trading strategy pretty much fruitless.

Maverick, I'd like to hear your feedback on how you regard theta. You maintain that there is no edge to selling premium vs. buying it - to me, that's the same as saying you don't care about theta (perhaps that an eroneous assumption). Personally, I rarely put on a trade with negative theta, but maybe that's just me. I would maintain that statistically speaking selling a spread with positive theta will be profitable a higher percentage of times than if one had bought the same spread. Am I missing something here? This thread got wound up in discussions of IV and gamma, all lots of fun, but what about putting the one factor that we all know is going to happen (i.e., time passing) on your side when you enter a trade? Seems like that is entirely implicit when discussing different strategies (or it seems to me it should be), but again maybe I'm missing something or don't know what the heck I'm talking about (which would become clearly evident were someone to strike up a conversation with me regarding trading gamma - really don't have a clue how people do that or what exactly they're trying to do other than the obvious - trying to make money).

Forgive me if I've overstepped my bounds as a brand spanking new poster - just thought I'd try to contribute and maybe learn something along the way. I'm not trying to be sarcastic.

I'm glad I stumbled across this forum - I've been looking for something like it for a while now.

 

[MajorUrsa]

Quote from CalPumper:

Agreed. All this talk of trying to trade IV is interesting, and perhaps it worked in the past, but I believe that the markets have become efficient enough in the last few years to render a vega trading strategy pretty much fruitless.

Maverick, I'd like to hear your feedback on how you regard theta. You maintain that there is no edge to selling premium vs. buying it - to me, that's the same as saying you don't care about theta (perhaps that an eroneous assumption). Personally, I rarely put on a trade with negative theta, but maybe that's just me. I would maintain that statistically speaking selling a spread with positive theta will be profitable a higher percentage of times than if one had bought the same spread. Am I missing something here? This thread got wound up in discussions of IV and gamma, all lots of fun, but what about putting the one factor that we all know is going to happen (i.e., time passing) on your side when you enter a trade?

You might want to read through the whole thread once again; the answer is there.

To summarize: the current price of an option contract is the same as it's expected value at expiration given the volatility of the underlying being the current IV, and based on a lognormal distribution of possible expiration prices.

This is a statistical value of course, and would need a lot of trials to actually arrive at that value, but it is the expected value nonetheless.

So, if you're selling, this is the average price you'd pay at expiration to clear the contract. If you're buying, this is the average price you receive at expiration. You will note that thus the premium received/paid is the average premium you will pay/receive at expiration. That is why Mav makes the statement.

One could argue that since sellers take on them a black-swan risk all the time the received premium will reflect this extra, anticipated risk. As long as the black swan doesn't appear a seller would be slightly in the advantage.

Ursa..

 

[CalPumper]

Ursa,
Thanks for that summary. I think I see the logic to that argument now, but I've still yet to hear someone put it in terms of theta for me. In short, if I'm given the choice of buying or selling something that is intrinsicly worthless, I'll stick to the latter. It still doesn't logically make sense to me if someone tells me that there is no advantage to selling air over buying air. So I'll continue selling it (with limitations on risk, of course - no naked puts for me, thank you). I favor calendars, iron condors and double diagonals. All of the aforementioned with nice healthy positive theta. Its been working nicely for me, I might add.
Maybe it would help to put it in terms of the insurance industry, net sellers of premiums I think we'd all agree. Is there anyone out there that would say the insurance companies lose as much money as they make on average by selling premium? Just a thought. I often liken my trading strategy to that of being an insurance company.

 

[Choad]

Cal,

Mav is saying that there can be no inherent advantage to selling ops, over buying them.

Option pricing just doesn't work that way. Think about it like this - if there was an automatic advantage, wouldn't everybody in the whole market just sell options? And of course if they did, any advantage would be arbed out quickly.

There is lots of mis-information (IMHO) out there that says "pros" usually write options. I don't believe this to be true in most cases.

So if you look at both sides:

- You sell me OTM options and make no adjustments (if you did adjust, then that's trading, not randomly writing).

- Most of the time you make some on the prem, but occasionally you lose a large amount.

- I lose a small amount more times than not, but occasionally I make (what you lost) a large amount.

There may be some small advantage to constantly writing options, but unless you can trade the underlying (ie adjust your legs) there can be no "automatic" edge to writing. The small edge might be seen in an index like the CBOE BuyWrite, ^BXM. But it's small and may just show up as the risk-free rate.