Writing options for a living

Quote from 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.
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OK, for everyone interested: Is there a component of the premium known as theta or not? I believe (make that know) there is, and I'm holding quite a few positions right now that if I were to annualize the theta it'd be one hell of a lot bigger than the risk free rate. I understand the dashed arguments above, making a little a lot of times, losing a lot only a few times. That would apply to those writing options naked, which I never do. All's I'm saying is that on average, a portfolio with negative theta (net buyer of time premium) just aint gonna stack up over time to one with positive theta (net seller of time premium). Can we all agree on that? I personally love going into a long weekend with theta at 1,000 on Friday. I can't imagine one would be happy holding -1,000 theta on Friday before a long weekend, but what I'm hearing is that there are quite a few people who maintain that it doesn't matter.
 
Quote from CalPumper:
[....]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.
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if you sell an option it is not "worthless" since it holds value for the person buying it - which means that there is always a probability of it having actual value. i'm as enamored of being long theta as the next guy. but that doesn't mean i don't recognize it's obverse risk: gamma. limited risk is simply that, "limited". in the long run, those risks will catch up with you if you don't learn how to manage them properly.


[...]
Maybe it would help to put it in terms of the insurance industry, net sellers of premiums I think we'd all agree.
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selling premium is not identical to what insurance companies do. they sell premium at prices ABOVE fair value. when you or i sell option premium, we are selling at or below fair value.

that your positions to date show positive returns may indicate that you have superior trading abilities. then again it may be simply a sampling or survivorship bias that will eventually net out.
 
Quote from CalPumper:

That would apply to those writing options naked, which I never do.
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If all options are priced so that the average expected outcome is exactly the premium you pay/receive than that also goes for any combination of options. If you receive premium for a vertical spread that premium is exactly the average expected value of that vertical at expiration.

Ursa..
 
Cal,

It's all in the risk curves of each and every spread you have.

Typically (of course, many many variations here), a short spread will show a max risk > max reward when graphed to the earliest (for diags) expiration. So here ya win more times than ya lose, but when you lose, you lose bigger. Net-net: same expectation.

Is there an automatic advantage to being long theta vs short? Nope.

But does trading low delta/gamma spreads and ops, and throwing in theta gains, give you more time and options to adjust? Could be, but then that's trading...
 
Quote from Prevail:

Is there a way to prove insurance premiums are over priced and options premiums are priced correctly or underpriced?
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First define what "correctly" means.
Are insurers allowed to make a profit? How much?
Is the market working efficiently? Do you mean now or in hindsight?
etc etc..

Ursa..
 
Quote from dummy-variable:




selling premium is not identical to what insurance companies do. they sell premium at prices ABOVE fair value. when you or i sell option premium, we are selling at or below fair value.
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Very well, let's define it in the context of d-v's statement. Is there a way to prove this statement?
 
Quote from Prevail:

Is there a way to prove insurance premiums are over priced and options premiums are priced correctly or underpriced?
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i'm not an actuarial accountant but that is their job. they determine and quantify individual and group risk profiles. the insurance companies then add a net premium on your insurance policy that covers the probable risk (i.e. what would normally equate to an option's fair value) plus the costs of doing business and a comfortable profit margin that meets market expectations. you can see this difference between insurance company rates and self-insurer rates.

as far as options, there are numerous studies that confirm the fair value of options when viewed over the long run. but the simplest reason to believe that options trade at fair value is that they trade in a market. no one would knowingly take the other side of a trade that would equate to a certain loss in a highly liquid environment. if liquid markets for insurance premiums could be traded (e.g.if i'd sell you life insurance for the next month and collect a premium for the risk of having to pay off for your untimely demise), i'm sure they would eventually trade at fair value.
 
Quote from Prevail:

Is there a way to prove insurance premiums are over priced and options premiums are priced correctly or underpriced?
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i would try to argue in a philosphical sense:

insurance premiums are based on statistics (i.e. the number of deaths per millions for such age, smoking-habits, etc.) and are allowed to be positive EV by the insurance market. because of barriers to entry, not everyone and their mother can be an insurance company.

options are based on B/S (or other generally-accepted) formulas. it takes into account statistics in the form of IV, but what has been said over and over by posters that I have the utmost respect for, is that the premium is not positive EV. If it was, everybody and their mother would be writing options. I'm on Maverick's side.

Peace.
 
Good posts, thanks.

The current sp volatility skew where otm puts are considerably more expensive than otm calls for the most part came about after the crash of '87. In other words, otm puts were more expensive after the crash than before.

Would you say market statistics changed after the crash so it became more likely for the sp to fall, hence changing the premiums, or would you say the market was temporarily inefficient and not accurately representing the risks before the crash or neither?
 
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