1. Options is a zero sum game and 2. the market is not ever THAT inefficient. Therefore, imo, randomly buying and selling, over say a decade, with various options, with various time to expiration will basically perform similarly. The reason for this is the option buyer's massive profitability potential to make up for years of losses, which are years of gains for the seller and the seller's massive loss potential. But....keeping losses under control, which some argue is an illusion for sellers, is the way to have an edge.
Prevail, Thanks for the reply. I pretty much agree with your ideas here. There may be some edge, but as a possible alternative pov, hereâs my thoughts on why it may balance out. When I compare the seller-that-exits-early with a buyer, these are the pros and cons I see: 1) The buyer and seller both can have limited losses -- so they are equal in this regard. 2) Time decay hurts the buyer and helps the seller. 3) With the same probabilities, the option price will go up a greater value than it will go down. This hurts the seller and helps the buyer. I think this #3 point has something to do with how the delta differs depending on where the strike price is in relationship to the underlying price.(?) But to clarify, here is an illustration which might help: (And to keep things simple I will disregard risk free interest and dividends.) Letâs say the underlying stock XYZ is now at 100. And the at the money 100Call is worth 1.00. (Here the volatility could be 15% and there are 10 days until expiration.) Next, I assume that normally in 1 days time there is almost an equal probability that the underlying price will move up or down X amount of points. For example there is a close to equal probability that the underlying price will move up to 102 or down to 98. But the price of the 100Call does not change equally. (And the greater the X amount of change, the more skewed this becomes.) That is: -If in 1 day the underlying price moved up to 102 the 100Call (with 9 days to expiration) would be worth about 2.25. This is a +1.25 price difference (i.e. 2.25 - 1.00 = +1.25). -Meanwhile if the underlying price moved down to 98 the 100Call would be worth about 0.25. This is a -0.75 price difference (i.e. 0.25 - 1.00 = - 0.75). So since the +1.25 and -0.75 value changes have about an equal probability of occurring, this will help the option buyer and hurt the option seller. And the idea here is that I think the above points of #2 and #3 will end up counter-balancing each other in the end -- at least in a theoretical math sort of way.
I searched a little my e-library and I found this. Hope it will help you. (Odds level = probability that the contract will expire ITM).
This really cannot be calculated with any degree of certainty. For instance some of those who finished ITM short may have been huge winners - if they were hedging the underlying and wanted to be called away, etc... It is impossible to know the context of each position as it is sold/bought against other contracts or underlying instruments. Many of the expiry ITM/OTM discussions seem to assume that all of the contracts were simply held naked, when most are not. Sellers are able to construct limited risk portfolios that outperform far more easily than buyers, but I won't try and convince anyone of that here There's Ansbacher and many others who have been selling for years and outperforming the benchmarks. Are there any CTAs/CPOs or funds that have been around for years BUYING options? None that I have come across. There are many sellers and a few "total position" dealers in options who run funds. If a buying strategy were viable, I think there would be funds doing so.
...And the only one who attempted a purely buying model (that I know of) is Taleb with Empirica and he closed it. I do think there are funds out there who have such impeccable timing with outstanding tools that they can leverage long puts or calls and be successful. I think it would be impossible to buy delta neutral month in and month out and not lose money.
Thanks for the posts guys. It does sound like there is an edge with the sellers going on. Also I've been thinking about what Prevail said and my last response -- about sellers that use early exits. And now, I can almost picture that they could sometimes actually have a slight mathematical advantage... If the expiration date is fairly close, then the time decay would be quite strong against the option's price. And if the seller used narrower exits, then my #3 issue (in my last post) doesn't really have much of an effect. So there may be a slight mathmatical advantage for some seller strategies... And then, it could be that the market tends to price the options a little too high -- for whatever reasons -- like: --more people buying options to hedge/protect their underlying stock positions, --or more people buying for the limited risk in the premium, --or more people buying because they fit people's psychology better (easier to think about, or always hoping for that rare huge volitility/price jump) -- etc. So if this is the case, then maybe it is true that the option price's implied volatilities are a little higher than they should be... Anyway, just thinking aloud here...
I find your point #3 very interesting. If that is true, lets go ahead and buy some ATM straddles. I am quite new to options and hopefully someone can explain whether point #3 is valid or not.
LoosenUp, I think the idea is fairly true, but... the price has to move a relatively huge amount for there to be much of an effect. So I think at least 90% (?) of the time there wouldn't be much of a difference. (And then don't forget that buyers have the time decay disadvantage.) In anycase, I'm pretty sure that mathematically there isn't any edge to the idea of a long straddle ( -- but if the options are priced fairly then there shouldn't thoeretically be a disadvantage either. However it could be a game where you often lose a little but then rarely win a lot).