I'm starting to build a custom options trading platform, initially with the intent to connect it to Interactive Brokers but should be able to work with other providers such as Reuters for marketdata. Was thinking to maybe associate with some traders and this site seems a good place to start. I am researching my own option pricing models, published one as part of my PhD but prefer to keep it anonymous for now. It's no silver bullet, or I would have used it myself instead of showing it to the world My direction of research is looking into fundamentals instead of relying on fast execution, as unless you're in the first league, you get no opportunities on the established exchanges, they're long time gone by the time you see marketdata. On the other hand if I have grounds to believe the true volatility is 20% and market pays 25%, then I'm in business. So I can't just rely on the implied vol, that's what the market believes and not the actual truth. Problem is finding where that truth is and that's what I'm working on. Will continue to post here, of course I don't expect anyone jumping up at some anonymous James Bond popped out of nowhere. The intent is, as declared, to leverage my knowledge by associating with other people who know and and interested in making money with options.
I read some papers from Taleb where he argues against dynamic hedging, more precisely that the risk from selling options is actually unhedgeable by replication in the underlier only. And that the only way to cover that risk is to also buy options, which is the recommended way to trade. I agree with the fact that selling option + dynamically buying underlier is not risk free. If I'm selling an ATM call option and buy 0.5 underlier, the market may crash in the next second, let's say to 50% of the previous value. I'm left with a huge loss. So yes, I should buy options to cover my risk but this creates a chicken or egg problem. Who sells those options I buy to protect myself in the first place? What does he buy to cover his risk?
Taleb is right. If you are short an option, you cannot really hedge all your risk it without owning another option. It's like saying, if you are long AAPL stock, you cannot fully hedge yourself unless you sell your AAPL stock. The question is do you want the risk of being short an option? Are you compensated enough for that risk? How painful will a 50% selloff be? If you can answer those questions, you can make decent money selling volatility. Probably more in the long run than Taleb makes being long volatility at Universa.
>> The question is do you want the risk of being short an option? Definitely I have a few questions: 1) Is there a place where I can trade Nikkei 225 options with 1x contract size, as opposed to 1000x on the Tokyo Stock Exchange? With the Nikkei index at =~ $200 (¥ 20,000), an ATM option expiring in 30 days values about $7 at 30% volatility. Selling one contract means $7,000. To dynamically hedge that I have to buy 500 Nikkei shares, which gives $100,000. My whole capital is about $10,000, I can barely buy options with this amount. Using Nikkei futures, which also have a contract size of 1000, I could decrease the amount to some 10% of it, as required by margin. Problem is that trading in futures is a terrible idea in case of a market crash. If I'm selling calls, they expire worthless so I'm keeping those money. Problem is that I have a futures contract expiring in one month which forces me to buy the index at $200 and sell it at $100 (assuming a 50% crash), and do that 500x. The chances for the market to recover in one month after such a crash are non existent so I'm due to pay $50,000 which means I lose my house. Buying the ETF (actual shares) wouldn't make me too happy but as you have seen, indexes do recover, even if it takes years. I may be out of the game for a while but I don't lose my house. Anyways, I'd rather go for a 1x or 10x multiplier in the beginning. So, is such a thing currently possible on Nikkei, or eventually on another index? I suppose next questions already depend on the answer to #1 so better wait for some answers...