Taleb's argument was the crash of 87, the asian flu of 98 and 9/11 all were suppose to happen once every 10 million years. In reality, the three events were 14 years apart. Go figure. This is why large sigma events are terribly underestimated. I generally trade contract neutral. Riskarb's joke about being long and short gamma is a common misconception when one is net long contracts. Being long 20 delta contracts is not giving you much gamma (there is very little gamma outside 30 delta options). I tend to be net long 15 and 20 delta options and short 40 delta options. This is for all practical purposes a short gamma position while being net long contracts. There is no reason in the world for people not to be long 15 and 20 delta options, they are cheap, usually .15 to .20. They have a neglible effect on your p&l while at the same time keep you in business and at the same time make substantial reductions in your overnight haircuts.
Yeah but spread out over 10 to 15 different strikes. And the short strikes are actively traded. And there are multiple months involved on the short strikes. Oh yeah, and don't forget the secret sauce.
actually haven't read that thread. i've seen it referenced so often in other threads that it's on my weekend read list. thanks for the book list. Natenburg is already my 2nd book, but Taleb was not on my list- now it is.
I agree that human beings are terrible at estimating the likelihood of future events. And, I think that Taleb's reasoning has some real-world utility. For example, the pricing of most LEAP contracts with expiry terms in excess of 1 year. Are you always contract neutral in each underlying? Or, do you make use of beta, VAR, or some other portfolio weighting to neutralize greeks? -segv
actually, your mention of MSFT favours my premise. the IV going into the report was 16%, not the 70%+ required- polar opposite. combine the IV with the $2 move MSFT made on the last release and the IV was way too low (and well below the past 20-25% norm for MSFT going into earnings). to my 'bad trade' example yesterday of ISRG: ISRG moved 24% today. still, you could have exited the position with a gain early today! even if you weren't nimble (over overslept!), you would have been able to exit with less than a 20% loss- more than offset by any one of the other short strangle paper trades i put on yesterday. i do understand the katrina type event risk. i suppose one could have a protective long put well OTM on in the Q's (or whatever) to provide some protection for the portfolio of strangle writes. obviously would have to calculate the P&L impact. that said, my 25+ years of investing has shown me that the huge stock specific land mines are rarely (if ever) rolled into an earnings release. reason being- an SEC investigation, loss of contract, or whatever is something material that must be disclosed in a timely manner. earnings release dates are set in advance. again, my strangle write premise involves writing it late the day before and exiting the following morning.
I'm tracking vols and stock's movement around report time for five years now. If anyone would see the results they would of be shocked to find out that vols/ABS % change ratio is the same from qtr to qtr. And all this happened while VIX went from mid 30th to low current levels. But here is why this game is not easy anymore : back in 01 vols on CREE use to collapse from 100 to 70 overnight , but now its collapsing from 42 to 30 (notice , same 30% like before). But in the old times vega gained 300bp vs only 120bp in current days. So if I was right/lucky and stock did not moved , my dollar and cents gains been cut by 2/3 (!!!). Same goes for vols expansion into report. Your ISRG (high nominal vols) example is just another reminder of the "good times" , will they ever come back ?
let me know if i am understanding you correctly: are you essentially saying that you support my short strangle (or straddle) premise if it is protected from catastrophe by a well OTM long strangle (ie: ~15 delta)? (sorry- being such a newb, i don't know which winged insect/animal this is called off the top of my head!). thanks.