Kelly fraction and vertical spreads.

Discussion in 'Options' started by TimeCorrosion, Jan 15, 2010.

  1. A typical scenario: a 5-point vertical spread trading at 0.25;

    If you short the spread, you receive 0.25 credit; the odds of payout are 1:20 (if you win, you are paid 0.25; if you lose, you are down 5);

    If you long the spread, the odds are reversed.

    Now if you have 0.9 probability of winning if you short, your Kelly fraction is a negative number;
    (0.05 * 0.9 - 0.1)/0.05 = -1.1;

    If you long spread, the Kelly fraction is 0.055.

    A more accurate computation is to take into consideration "continuous" outcome rather than binary outcome (ie, either gain 0.25 or lose 5). I haven't done this yet (need some time to program). But it seems that Kelly fraction favors long spread trades.

    Any thoughts?
  2. u21c3f6


    Kelly favors a profitable scenario. In the set-up above, the long is +EV and the short is -EV.