So I have a strategy that involves identifying great companies at a low implied volatility and low price relative to intrinsic value and then buying some 1 year deep OTM call options. It worked pretty well with Wells Fargo in April 2013 when I tripled my money in a month. The whole black scholes model assumes the random movements of the market are unbiased. But if you find something where the movement is definitely biased in a particular direction, and that option is long dated enough for that bias to be relevant, then black-scholes can be very wrong... Empirical studies have found that on a long term average, writing puts is the most profitable, calls are neutral, and buying puts is unprofitable. That's about what you would expect a priori from the combination of two things: 1. the long term upward bias of stock movements, 2. fact that implied volatility is higher than realized volatility. When you're trading puts, both factors work in the same direction, but when you're trading calls, they cancel out. Unless you find a rare situation where ivol is low and the upward bias of the underlying is high, like I try to do. I guess you could also do the reverse of that and sell calls when ivol is high and there's a downward bias. I did that with TSLA lately and also made bank... lately I've been looking at buying Hormel 37.5 Jun calls but IB wants 5x the price of the calls in margin, what the fuck? It doesn't do that on other tickers.
Here is the problem. You buy a bunch of lottery tickets and hit one. Then you will spend all your profits trying to replicate that. In the past, this has not worked well.
nope, it's still asking for 2x the cost of the calls in margin to buy them. Something's buggy with their algo.
The idea is that on average the losses will cancel out the gains, if you were just buying calls randomly. But if you have any ability to predict what will happen to the underlying then you can do better than breakeven. Or take for example the SHLD Jan '18 5 puts priced at $1. That price is based on black-scholes but it amounts to a 20% likelihood that Sears will go bankrupt. The actual likelihood is probably more like 80%. Even conservatively at 50/50 chance of a sears bankruptcy the expected value of the option at expiration is at least $2.5, which is a 77% annualized return. So I'm willing to buy any number of those for $1.
Given the market I would recommend two things...don't go so far OTM as markets take a while to come back (years). Also, go out more than 1 year, i.e. 2018 LEAPS. Other than that, the strategy is just buy and pray. Margin requirements are incorrect so need to call in.
Are Sears bonds of that tenor trading at $.20 on the dollar? If so it seems like pretty easy money arbitrage.
If you were to buy Wells Fargo 1 year LEAPS ATM in April 2013 instead and held to expiration April 2014, you probably made > 20X your investment in 1 year whereas the DOTM calls could be worthless.
Correct, but you have to include expectancy. OTM options have a very low success rate, while ATM would be higher for the same $ amount spent.