Don't get me wrong, I like to hear very much from Mav and Risk as well, just that for this +expectancy question, we just got round and round answer.
Writing options for a living
- Thread starter torontoman
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Quote from fengshui-123:
Don't get me wrong, I like to hear very much from Mav and Risk as well, just that for this +expectancy question, we just got round and round answer.
LOL,
While their answers are not rigorous. They do provide insight.
It's naive to think that expectation is idempotent.
I suggest you pony up and visit amazon.com or get educated, which ever is cheaper.
On a personal note, you should be thinking about yin'n and yanging Julie Chen.
Otherwise, fengshui = leach.
Mr Cluseau, I'm glad to hear that you understand what Mav is saying. Please be so kind as to explain it to us.
My measure to make sure I understand something is whether I'd be able to explain it to someone else. In that process I learn the most and often encounter problems that either make me rethink or make my conviction stronger. If you're not able to explain something that is a strong indication you miss something in your reasoning.
I repeat that I have tremendous respect for Maverick and (without saying) for Riskarb. If he's to busy to answer a thread that, as he predicted
went on for very long, I respect that completely. We all have busy lives and we all know how hard it is to keep up with this site.I even am willing to accept his statement about the +exp at face value, because he is the one saying it. I have never said it was not true, I'm just stating my own reasoning and examples that show why I have doubts.
The fact that I do accept Mav's statement is sadly of no use to me, because any strategy I can think of does not have these properties.
Anyone finally understanding this (very important!) question must have gone through the same thought processes. I have re-read the thread 6 times now, and I'm not able to find an explanation (as in explaining, showing, demoing) of how this would work.
As said, I'm willing to accept Mav's statement as face-value, because I respect him. However I'm not willing to accept condescending remarks from others that only say to read up, or stop being sophomoric.
I'm certainly no options professional but I have a thorough understanding of options, beyond that of most option-book authors on Amazon. If I don't understand this issue, very few will.
Ursa..
god knows why, but let me re-enter this discussion and try to add a thought or two.
first of all expectancy as i understand it is the probability of profit less the probability of loss. if you make $1.00 on ten trades and lose $2.00 on 5 trades you have zero expectancy.
$1*10/15- $2*5/15 = 0
bump your average win to $1.01 and you have achieved +expectancy
1.01*10/15-2*5/15 = .007
and so on.
in any trading environment the actions of buyers and sellers drive the price of an asset to "fair value" at any and every point in time. fair value = mid-point between the bid/ask spread = zero expectancy.
why are options a negative expectancy game for any retail trader? because of slippage (the difference between bid/ask spreads) and commissions. how much is this negative expectancy? i don't have the data but here is an educated guess from experience.
let's assume that the average option price is $4.00. the market for that option is likely to be 3.90 bid/4.10 asked. for a retail customer to buy that "$4.00 option" she has to pay some market maker for the privilege of ownership. let's say that on average you can shave a nickel off the B/A so that means on a round turn your cost is $0.10 in addition to the fair value. add another penny in commissions and your net cost is $0.12. that leaves us with (4.00-.12)/4.00 as the probable payback on the trade. or 97% payback. that's about the same odds offered by casino blackjack.
okay, if we're all on the same page, every option trade is therefore a negative expectancy event. so how does anyone facing these odds make any money? because as John (Mav) implies, options are not discrete events. they are not coin flips or other binary either/or situations.
a skilled trader has the ability to "alter the odds" so to speak by bringing individual options into combinations that, while on their own offer only negative expectancy, in combination they provide positive expectancy. it is in essence the TRADER'S skill that creates positive expectancy.
one way to maybe get a handle on how this operates is to "reverse engineer" a trade. when you buy a simple call if you track the life of the value of that call from the moment you bought or sold it you can see in retrospect that there would have been several times that the trade would have been profitable or at worst a situation where it would have shown the least loss. blindly or randomly entering and exiting trades (or holding them to expiration - which is the same thing ) will always result in the negative expectancy outlined above (i.e. you will receive 97% payback on average until your bankroll is ground to nothing).
but the skilled trader - through deep experience - learns to select those ripples in an option's history that either result in reduced losses or better than average gains. there are so many permutations and ways for these momentary +expectancy events to occur that there is presently (to my knowledge) no computer that could model and execute on it besides the human brain.
the bottom line though is that options, while at any moment are offered as zero or negative expectancy events, when you are in a position, the continuous changes to value mark opportunities to overcome the original negative expectancy. it's as if you have heads on a coin flip but somewhere just before it lands you can see that it is very likely to land tails. if this observation leads you to quickly withdraw most of your at-risk bet, then you have skewed the odds in your favor.
first of all expectancy as i understand it is the probability of profit less the probability of loss. if you make $1.00 on ten trades and lose $2.00 on 5 trades you have zero expectancy.
$1*10/15- $2*5/15 = 0
bump your average win to $1.01 and you have achieved +expectancy
1.01*10/15-2*5/15 = .007
and so on.
in any trading environment the actions of buyers and sellers drive the price of an asset to "fair value" at any and every point in time. fair value = mid-point between the bid/ask spread = zero expectancy.
why are options a negative expectancy game for any retail trader? because of slippage (the difference between bid/ask spreads) and commissions. how much is this negative expectancy? i don't have the data but here is an educated guess from experience.
let's assume that the average option price is $4.00. the market for that option is likely to be 3.90 bid/4.10 asked. for a retail customer to buy that "$4.00 option" she has to pay some market maker for the privilege of ownership. let's say that on average you can shave a nickel off the B/A so that means on a round turn your cost is $0.10 in addition to the fair value. add another penny in commissions and your net cost is $0.12. that leaves us with (4.00-.12)/4.00 as the probable payback on the trade. or 97% payback. that's about the same odds offered by casino blackjack.
okay, if we're all on the same page, every option trade is therefore a negative expectancy event. so how does anyone facing these odds make any money? because as John (Mav) implies, options are not discrete events. they are not coin flips or other binary either/or situations.
a skilled trader has the ability to "alter the odds" so to speak by bringing individual options into combinations that, while on their own offer only negative expectancy, in combination they provide positive expectancy. it is in essence the TRADER'S skill that creates positive expectancy.
one way to maybe get a handle on how this operates is to "reverse engineer" a trade. when you buy a simple call if you track the life of the value of that call from the moment you bought or sold it you can see in retrospect that there would have been several times that the trade would have been profitable or at worst a situation where it would have shown the least loss. blindly or randomly entering and exiting trades (or holding them to expiration - which is the same thing ) will always result in the negative expectancy outlined above (i.e. you will receive 97% payback on average until your bankroll is ground to nothing).
but the skilled trader - through deep experience - learns to select those ripples in an option's history that either result in reduced losses or better than average gains. there are so many permutations and ways for these momentary +expectancy events to occur that there is presently (to my knowledge) no computer that could model and execute on it besides the human brain.
the bottom line though is that options, while at any moment are offered as zero or negative expectancy events, when you are in a position, the continuous changes to value mark opportunities to overcome the original negative expectancy. it's as if you have heads on a coin flip but somewhere just before it lands you can see that it is very likely to land tails. if this observation leads you to quickly withdraw most of your at-risk bet, then you have skewed the odds in your favor.
Let me clarify all this tread for those who still do not get it. Complex strategies like butterflies, condors and such are just for pros who have a smaller spread then retail traders. Spread will cost you about 15-20% of your projected profit if you are a retail trader.
No matter how much one knows about expectancy, greeks and hedging, if you do not know how to spot reversals you will never make money in options markets .
If you know how to spot or forecast reversals, all you need to know is hot to buy a call or put or how to write credit spread.
All the theory goes out of windows if you cannot spot reversals. So concentrate on that.
No matter how much one knows about expectancy, greeks and hedging, if you do not know how to spot reversals you will never make money in options markets .
If you know how to spot or forecast reversals, all you need to know is hot to buy a call or put or how to write credit spread.
All the theory goes out of windows if you cannot spot reversals. So concentrate on that.
Great post Mike. I wasn't going to add anything further to this thread, but you pretty much summed it up what I failed to communicate. You are a better writer then I. Maybe from now on, I'll have you write my posts. LOL.
Once again, you articulated what I tried to say and to the point with absolute clarity. I have nothing more to add. Good job!
If you sold 1 put for ten individual stocks , how do you know who was those ten people that bought them or why they did it? Maybe five of them were MM , but another five bought them as insurance(read:I don't mind to pay premium , I want to sleep good at night) to hedge their portfolio? In this case , you become an insurance company/agent that always make money in the long term. So in this case , is my initial entry have a +exp?