Actually, payoff = probability*(reward/risk) Typically, the higest payoffs involve the ATM or slightly ITM strikes. Calculate probabilities thusly: stddev=(exp(future price/current price))/(volatility*sqrt(# days to expiry/252)) then in a spreadsheet use =normsdist(stddev) to get probability Don Fishback was big into this with his ODDS software and claims of 90% winners several years ago. I wonder what he is doing these days?
You are right daddyboy. Your viewpoint is spoton. Thanks. I have faced losses even after rolling out because after a while enough margin is not there and my broker(IB) starts closing positions. I am trying to follow following strategy and would appreciate your comments. I am tradind credit spreads on FTSE which is European style so exercise canot come early. When I lose twice the premium I have earned I close the short leg and wait few days to get better opportunities for another trade. I leace available funds at 60-70% with IB I also sell credit spreads on calls and puts so everything cant go wrong. Your comments appreciated. Thanks
The problem with selling strangles or condors is that you decrease the probabilites of either leg finishing OTM. Of Course they can't both be losing positions, but the loss you might take on one leg most likely won't be made up for in the two premiums collected. In other words, you have a greater probability of taking a smaller loss, than by using one side only. In order to make money, you're going to have to predict something. If you get the direction of the underlying wrong, it will be extremely hard to make money even if you get IV right.
<i>"Otoh if the account has $10 million then risking $240 k is reasonable (2.4% of total account value))."</i> How many expired cc trades at +$100 credit on 25pt SPX spreads would it take to recover one event's loss? That was the point of my post. Just because the ODDs may be 90% or greater probability of success does not mean an account won't take big hits sooner or later. The OP asked what was missing from the inherent risk factor. Just one example of real & present danger out there.
a some things: Rolling out=taking a loss. I hate these people who say they are adjusting when in reality they are losing and just opening new trades. Just man up and say i lost (such as I did last week). I still think ICs are okay, because you can make that condor spread its wings as far as you want. If you think the index is range bound and not going to go up or down a X % points or X# of sigmas in the next 2-4 weeks, I say use the IC to increase your return on the same margin req. Yes, i understand the idea that 90% of the time you win, 10% you lose...but if you manage correctly, the 10% time you lose, you should be able to know when to cut your losses and limit the loss not to the entire margin req. (which of course would make all of this totally not worthwhile), but rather 10-30%
The whole problem is that you never know when black swan events will enter the market and cause you a huge loss before you can manage your position. That 10% time that you lose can end up being more than you ever made from the 90% wins. There is no way you knew that we would have a 500 point down tick in the stock market recently. If a person spreads/hedges and doesn't take on too large of a position, then maybe they can survive those 10% times. Of course you limit profit by limiting risk, but wouldn't you rather still be trading your original account in 10 years instead of blowing up every few years and starting over? Check out what Max Ansbacher is doing in his hedgefund.
I totally agree except that a black swan event will result in the max loss of an IC position. Thus the importance of sound money management. db
I wouldn't call a 500 point down tick a black swan event. As a matter of fact I had on an IC on rut and still managed to make a small profit on that day. Best db