Why can't it double prior to collapsing? Isn't it just taking a directional guess on volatility? Yeah I guess volatility is mean reverting, so is that in itself an edge? I understand (I think) that options are tools one can use, but does the edge come from making same old directional bets? If someone could clear this up, would be appreciated.
Selling long dated (leaps) ATM straddle is more a "pure" volatility play; low gamma big vega, while 30 days to expiration straddle requires delta hedging to mitigate gamma risk. "Volatility" is an elusive term.
Not necessarily. If you have a favorable risk:reward ratio, you aren't "picking up pennies in front of a train." Of course, a favorable risk:reward ratio doesn't guarantee profitability either. You can bleed to death with lots of small losses like some trend followers. But the equity curve and risk characteristics are very different. Also, some option traders claim to structure much more complex trades which collect premium (like credit spreads) with a much better risk profile...
Let's take the (by no means unusual) case of a given stock's volatility being at 100%. Take a wild guess at what the chances of doubling that volatility is? Is it a "guess" to bet that it will either stay the same or decrease? All other things held equal, either one of those will benefit a credit trade. Now, consider the chances of its doubling when it's at 90%, 80%, etc. Are these still "just taking a guess", or is there something that (strongly) influences the probability of outcome? I also assume you know that risk is additive. Is the improvement in risk/reward a "guess" if one of the types of risk is eliminated or minimized on entry? This is absolutely not intended to say that credit spreads are an end-all-be-all of options. As @ffs1001 noted, "Credit spreads are just a tool which are no better or worse than any other options strategy - in the same way that a screwdriver is no better or worse a tool than a spanner in the toolbox of a plumber. It just depends on what the job at hand requires." I'll also add that if you don't understand a strategy's pros and cons, you absolutely should not trade it; that would just be a complicated way to throw your money in the trash. Credit trades are often called "non-directional", which is not quite correct; however, they are not by any means the "same old directional bets". If we focus solely on price movement, then credit trades are profitable if the price goes in your preferred direction, sideways, or even somewhat against you, whereas debit trades must go in one direction only - and far enough to overcome the debit and realize profit. If you're choosing which one of these should be referred to as "directional", then the credit trade is not the right choice.
Risk:reward ratios are always balanced by their complementary win rate. The default overall probability is 50/50 regardless of which one you pick - otherwise, we would all just choose the "more favorable" RRR, and buy islands of our own. Identifying situations where it's not exactly 50/50 and executing trades that take advantage of them... that, as I see it, is the most important skill in trading. Well, yes. There's generally an optimal point, or narrow range; the rest of the curve is not quite as efficient, and more likely to produce a losing outcome. (Notably, even the optimal point for us retail traders is still subject to a fair amount of friction, which skews it negative.) Heh. Yeah, I've noticed that there are a lot of people here claiming a lot of things regarding their trading. Very, very few actually put it on the line by proving those claims - i.e., posting their entries and exits as they're made, and letting the market show whether they can "walk the walk."
"Taleb's central critique of "The Bell Curve, That Great Intellectual Fraud," (the title of Chapter 15) is that it is often applied to areas that are subject to the dynamics of Extremistan, even though it only accurately describes Mediocristan." I appreciate you replying to my questions. I can understand when retail traders use options to make directional trades (including flat), but I don't understand how they can get an edge without betting on direction. Do you (or anyone else) understand what @destriero meant by "trade ATM vol."? Does it mean trading off volatility surface via calendar spreads (using some big words here I hardly understand)? That sounds to me like something retail trader may be able to gain an edge with.
The challenge here would be determining which category credit-vs.-debit trading falls into. Option trading in general is indeed subject to fat tails, but I'd be very hesitant about claiming that one has less overall risk than the other. Your cite of Taleb seems to imply that you believe it to be applicable here - or at least that you have a distinct reason for discounting the use of the bell curve for options. Do you? Consider a straddle, or a delta-neutral strangle or iron condor centered on the spot price. Where is the directional preference in any of these? I would be the last guy in the world to speak for @destriero - for one thing, I pretty much always learn something from reading his posts, so I'd really like to see him explain - but I would assume, through the process of elimination, that (since he's counter-posing this to "underwriting disaster insurance", i.e. credit trades) he means debit trades. (Best guess, which is likely not very good: spreads are fairly well balanced with regard to most greeks, but volatility skew is non-linear, and should cause the premium to increase rapidly as it rises - which is why you want to enter debit trades at low volatility.)
Its great to know how to calculate optionality. But you won't know until you start risking money and put the theory to practice. Credit spreads are profitable when traded correctly. THat same applies for anything in life. Its determined by the trader, his skillset and knowledge and experience trading credit spreads. Right now I have the SEP 19 2795/2800/2950/2955 asymmetrical IRON CONDOR. I'm up $140/contract.
The variance risk premium is mathematically embedded in credit spreads because of the nature of the stock market. Brownian motion = randomness + positive drift The seller of premium automatically is rewarded for the risk taken. If that seller is knowledgable and has some skill realizing the risk premium he will be profitable in the long-term bucking against the statistical outcomes. The outsized losses credit spread traders incur is natural to the position, so the trader should be very aware of tail risk and measure skew and kurtosis like a hawk and most importantly, position sizing. You cant blow an account if you manage risk like a beast. Its all about awareness.