Atticus I love that stuff on gambling systems. Great thread. Having got curious and studied them and tried them many many years ago. My other thread about trying to rationalize the IC system, finally became clearer in my mind. I can´t put it in your technical jargon, but essentially, I was wrong. It was a ROSY picture I painted trying to figure it out as I typed. It is much worse. The Iron Condor is cheaper to put on, because only one side will be covered by margin. However, what in hindsight and some second thoughts I thought of, was that if a sudden market move occurs, you lose one spread, presumable all of it. Or 100% margin and three commissions for the two spreads. One winning spread will go to expiration presumably. In essence, no matter what happens, you are going to lose 100% of margin. Plus three commissions. You cannot make that back, trading monthly, or two monthlies is my conclusion. The problem is; with COMPOUNDING, or some call it pyramiding. To make credit spreads, and Iron Condors profitable, all the time, you need to pyramid, or compound to earn any decent return. Therein lies the fault with the system. If you compound, or pyramid, when you do get hit, you are going to lose everything you have made previously, because your bet size kept getting bigger. You can add to that with the 20% POT early close. If a nose dive occurs in the market you are not going to get out fast enough. In a slow market you probably could, but unlikely. Somebody mentioned EXPONENTIAL. The speed of a drop, or move is going to blow up the premiums, to a gargantuan size and this will occur near to, or before 20% of POT. After that, you are probably going to lose 90% of your margin anyway. At least that was my experience last year TWICE. As you say, you can make credit spreads work. By judiciously using them in a BULL market trend, or in a BEAR MARKET trend, only doing the appropriate credit spread according to direction. However, as such a strategy using 100% to make 2% after paying off the commissions, that is hardly a strategy worth trading. Especially if you are not pyramiding, or compounding. Might as well junk the system and go to something more rewarding. A system where you can control your losses better and compounding is not such a side effect. Good discussion and I guess I have solidified my own thinking through it and will stay out of credit spreads forever, or Iron Condors. Just not worth it. There are easier ways to make a buck. While volume is one key in trading movement. I like more to describe it as pressure in my own indicator of same. I no longer look at volume. What I use is something a little easier and more practical that tells. It is called a clear simple protracter from a school kids geometry set. Anytime you get price movement at around 65 degrees or 70 degrees you have a blowoff and I suppose behind that is volume, when placing the protractor over the price chart? No need to guess if the volume is enough, the protractor angle will tell you, or at least it does for me.
To answer both of you at the same time: the sudden moves of 2008 show BS to be only a useful fiction (or a crude approximation of the truth). You need the greeks generated to show you what your risk profile looks like. The world, however, moves very much differently: it's more of a yes/no, on/off, than a continuous and contiguous volatility smile, smirk, frown, or whatever. Else I would never have made that money that weekend on that Lehman strangle. A crude approximation of the truth <> the truth. IC's are more based on the vol curve being the truth. No one has used BS with the same IV throughout since forever, btw.
Thought experiment... I buy a stock for $100. I will sell it if it reaches $110. So I have a potential of a $10 gain and a $100 loss. The discerning reader my suggest that I will not let the stock price go to zero before buying it back so my risk/reward ratio may not really be 10:1. And yet... I sell an option spread and collect $.50 There is a $10 spread between short strike and long strike. So my risk is $.50 and reward of $9.50 Well, atticus yells constantly, that's a 19:1 risk/reward. Question... If an investor in the stock would not let the stock go to zero, but likely have a stop loss in place, why is it assumed that a spread seller would not do likewise?
Thought experiment... An admitted amateur who knows very little about effective back testing fails in his efforts. Another who has done back testing thinks he has been successful with it. A little thread gazing or a question may have revealed that this person has an exceptionally advanced method of back testing in the view of some who know the field. Yet the amateur concludes his own failure is conclusive evidence that the other's efforts have no value. This is not my father's logic.
falconview, I rewrite my posts two to four times to organize the development of a thought and attempt to communicate it successfully. A well know person who's name I cannot recall was asked how long it would take to prepare a speech. He asked the requester how long the speech was to be. The requester responding by asking why it mattered. Because, if you don't care how long it lasts, I'm ready now. If you want it to be 30 minutes, it will take me a week to prepare. I'm sure you get my point regarding your posts.
Howard, first I assume you meant "So my risk is $9.50 and reward of $.50". The problem is that if you have a stop loss in place, then you may not make the 100% sometimes when you would have otherwise. I probably can't say it as clearly as I would like but Larry McMillian reviews this in his book McMillian on options - he says some people claim OTM credit spreads win 90% of the time and they can close them early to mitigate risk - however sometime you might close a spread that is looking bad early, only for the index to rebound and you never had to. So, the situation is like this: Months that work perfectly say you get $.50 Months that are terrible, you would lose $9.50 if you didn't have a stop loss at all. However, if you have a stop loss, maybe you will only lose say $2.50. However, there is a cost to this in that instead of profiting 90% of the time, you might profit 75% of the time. So, if you do spreads with no stop loss, you might end up with something like this for 8 months: Month 1: Gain .50 Month 2: Gain .50 Month 3: Gain .50 Month 4: Gain .50 Month 5: Gain .50 Month 6: Lose $9.50 Month 7: Gain .50 Month 8: Gain .50 However, with a stop loss, it might appear that the above trades would be profitable overall, however this could happen: Month 1: Gain .50 Month 2: Lose 2.50 Month 3: Gain .50 Month 4: Gain .50 Month 5: Gain .50 Month 6: Lose 2.50 Month 7: Gain .50 Month 8: Gain .50 So, in month 2 for example, the index was going against the trade and you close it to minimize the loss - then it rebounds to where you would have got the full credit (like in the first group). However, you took your loss already and can't get that back. Anyway, I'm not saying spreads can't be profitable and/or that stop losses can't help, but they may not be the magic bullet either of course. JJacksET4
What I am doing is definitely not a magic bullet. You are preaching to the choir with your example. If you read my summary of results earlier in the thread you can get an idea of my win/loss ratio using my entry rules, management rules and stop loss rules. As of tonight I have two more wins. That's 128 total spreads with 8 losers. I have also qualified these results regarding market conditions under which these spreads were traded.