So I believe the big boys are usually trading the underlying. But, if you had a 60 % W-L ratio on the short term direction of delta and you were using ATM , near expiration options as your vehicle.....is gamma enough to over come theta, slippage, etc. to achieve a positive expectancy ?? Any studies?? This is asked in the very general sense ....thanks @sle Anyone else. I've had some positive results on this but only on a small scale, just wanted to open it up
a lot of the answer to that question depends on the robustness of your tradingsystem in predicting the direction of the underlying ... I know someone who can do this ...
If you're very good in picking direction and velocity, yes you will always outperform theta and assuming highly liquid options. A very big IF though to do on a consistent basis.
We have all seen them, those SPY options trading at dimes a few days before expiry that end up 5$ in the money...If only... So yeah hypothetically you can overcome theta easily enough but the 60% w/l ratio is not enough. In the cases you refer to your loss is likely to be 100% every time you get it wrong. Your profit on the other hand could be 1% or 500%. So my answer would be that the starting point you give is not enough of an edge to overcome theta consistently.
@TrustyJules I try to keep the losses at 50%, first bad close and I'm out. But to your point, a gap against me and I'm close to 100% loss on a specific trade. That dosen't happen much with my system but I can still be blind sided. On the other side, many times I get a bigger move than anticipated in the proper direction, gamma kicks in and I'm up more than 100%. So it is really a matter of does it have positive expectancy. As I said on a small scale it has....still a work in progress though. A 70 % win ratio would solve all problems ! Haven't gotten there....
No, I need the occasional big pops to offset the gap losses. I have an identified S/R level where I take profits. But, if there is not upside to the next level in the underlying I don't enter. For example if I'm looking for a 1 pt move in the stock the option will move .50 if I'm right (50 delta ATM) So I would not enter a trade if the premium is more than 1. This 50% rule is just to keep me disciplined on the entry, not paying too much time premium, etc. In reality the systems filters out all but the most liquid options. I also use time stops, if it is not working on day 3 I'm out.
An edge I found in options, the pricing doesn’t take into account technical chart patterns. Than again why should they, no one believes in technical analysis.
Just for the record, this isn't true - volatility changes have a major impact here. Furthermore at low volatility gamma would be stable across all strike prices whereas it would be high ATM if volatility is high and lower ITM or OTM. It has a huge impact. For the rest of the response I am assuming stable volatility in the period of your trade. I am also taking that you trade ATM, one week or less from expiry and with your 50% rule. Gamma increases ATM closer to expiration - but what you need is for the changes in the underlying to kick through faster than the theta loss. The answer to that is dynamic in various directions as it will change with the price of the underlying, the shortening timespan, option price and so forth. Its possible to look at a ratio between the theta and the gamma to arrive at a price to hold 1 gamma. As ever cheap gamma is good to own. Professionals will use such ratios to hedge through buying or selling of the underlying as and when the delta changes. What you should beware of though - as I started out by saying - the move in volatility makes all the difference. If it dropped in the mean time your theta can overcome your gamma and vice versa.