Maestro, First let me say that I've always liked you and I know your a serious trader but I have to believe you are merely being fooled by randomness. In my understanding, 80% of options trading is nothing but Institutional hedging. The real evidence of your claims would be in your funds performance numbers , so why not just share that if you will. I know you don't have to but if you would, I would greatly appreciate it.
What does his fund performance have to do with a scientific discussion. Maybe the fund lost due different reasons or gained due unrelated reasons?! He tried to present here what I believe were kind of a combinatorial approach albeit a relational one and he gets attacked for it by others! Why not just civilly prove him wrong or ignore his methods? The facts are in the solutions presented and NOT his performance. How can his performance help me understand the mass/herd behavior? As in the masses don't have the courage or are wiser than to take the first step...
If, as you say, 80% of options trading is institutional hedging (and I would agree with you), then wouldn't it stand to reason that dynamics in the hedges (particularly in movement of the hedges in aggregate - i.e. like the mentioned swarm theory) provide some relevant information about directional bias by the institutions (either in a supportive or contrarian manner), particularly if it's the institutions that have the greatest effect on market movements?
Institutional hedging is nowhere near 80% of options trading in equities. It is hedge fund speculation. Maybe 20% to 30% is institutional hedging. In the index options, it may be as high as 60% that is hedging activity, but even that is debatable.
If they are hedges then they come AFTER the fact not before and even if this had some merit, I guess we would just call this a trend right ? I don't see how it could go past that obvious assumption and be used otherwise. The options markets are filled with the smartest math minds in the entire industry and arguably the entire world. I believe Maestro is on to something but I don't think it's any holy grail beyond a simple edge. imho
That may be so. But I've had many dealings with professors of finance who are brilliant mathematicians, and what stands out is how absolutely, incomprehensibly clueless most are about how the math is used in the real world. It's a mistake to think that brilliance in math correlates to an ability to trade successfully.
Absolutely fascinating discussion! Here's my take. The famous poet John Donne once wrote a masterful poem that says, among other memorable phrases, "No man is an island, unto himself, alone..." Human actions are amazing interdependent. Your actions influence everyone around you, and then their actions influence others, so that everything flows outward in concentric circles. What this means for the markets, is that people often seem to act in herds, and things that everyone assumes are independent aren't completely independent. When you discover where the correlations are, you can use them as indicators and predictors that sometimes take a little time to work their way through the markets. Hence, an edge in information flow can be used to advantage. Secondly, since groups often operate as if they are dumb as posts, someone who thinks a little more clearly, or possibly in a contrarian manner at times can be wiser than the average guy. This does not mean that you have to be smarter. In fact, being smarter can have delusional effects at times (LTCM comes to mind here). Being humbler is always an advantage in the market! Third, I have traded hundreds of index options. What may come as a surprise to rookie traders is that the price differentials between option series vary quite a lot, and often the skews are fairly substantial which lets you know the directional sentiment of the market in quantitative ways. It also means that just adopting one particular strategy designed for that particular skew may work very effectively if the market is conducive. In fact, many strategies can be implemented with minimal risk if the timing is right for them. That said, no option strategy is completely risk free when originally implemented, and no one can predict individual stock or index behaviour with 100% accuracy. On the other hand, some may be able to exceed 50% (random)with regularity using some basic notions that apply to all time frames!