You mention BSM assumptions in the same vein as empirical data. Obviously there is a large 25-delta risk-reversal premium (down/out skew) on all equity indices, less so in the component equities, and often individual equities have up/out skew. There is no bias or alteration of expectancy for the buyer or seller if using BSM. The vol-surface is modeled as flat in price (strike) and time (duration).
Thanks very much to everyone for the thoughtful replies (as well as your patience in indulging the questions of someone new to this part of the game). I think was less than clear about what I'm actually asking, so here's another way to phrase it: What exactly would a Monte Carlo distribution of annualized returns from selling call/put options look like? Based on the BSM, I'm assuming that it would have a mean equal to the risk free rate (sans transcation costs). And I expect its stddev would be quite large (and the Sharpe, quite small). If I'm understanding atticus correctly, the mean is actually zero. I'm in no place to argue with that, but it still leaves me scratching my head...
I think I am now confused, jazzguy... What precisely are you trying to achieve? Are you looking to determine what a randomly selected portfolio of long ATM puts is likely to return over a sufficiently large number of iterations?
Mainly because while I have an astronomical amount of EOD/intraday/tick data on stocks and futures, I have nothing on options. And the thought of purchasing and/or collecting data for every put and call strike/expiration of every stock in my basket is pretty daunting. I was just hoping to get a sense from those more experienced with options if this is even an avenue worth pursuing. (Just so you know that I'm not a complete noob: I'm a former game programmer turned full-time algo/bot trader with over 10 years of experience in trading system development. I have a live intraday system that my bots trade each day that works quite well; I'm just looking for ways to increase my Calmar so I can use my available leverage more effectively. ) Married puts seemed like an interesting possibility that I'm sure others have already explored. If anyone else has been down this path, I'd certainly love to hear their comments/suggestions...
Sorry, I think I've been unnecessarily obtuse about this, but its probably because I'm not an option trader and am not up on the lingo. I started down this path after reading an article about an EOD long-only stock trader who used married puts as part of his strategy. I have no idea what his entry criteria was, but his hold time was 10days and he used a volatility-adjusted target. Instead of a stop, he used a married put. So here's what I'm asking: Let's say I have a positive expectation EOD system where every 10 days I buy 10 stocks and hold them until a precomputed target is hit or I hit my timestop (10 days). The only problem with this system is that it gets hit pretty hard during Black Swans. So I decide to add options to the mix: When I purchase a stock, I buy a near month ATM put (with at least 10 days left to expire). If my target is hit, I exit my stock position; if not, I exit at market after 10 days. In either case I hold the put option until its expiration. The reason I hold the put option until expiration, is that based on my understanding of the BSM, over time the gains and losses of the puts will more or less cancel each other out, less transaction costs plus some multiple of the risk free rate. So my question is: How much performance will I give up by adding puts? Will the negative expectation of the puts be so large that they will cancel the benefits of a smoother equity curve?
Buy options at n-vol -> dynamically hedge with shares and/or options -> realized vol = n+1 -> +excess return. You want excess returns through your hedge (holding puts to exp), which I would expect in practice will result in -excess return.
I have absolutely no idea what that means, lol. Can you dumb it down a bit for me? Actually, I'm trading the puts with absolutely no edge (in the above scenario I WANT them to expire worthless) and therefore a negative expectation, which (hopefully) is smaller than the expectation of my long stock strategy by itself. I'm basically looking to give up some of my absolute return for a smoother equity curve.
It means that the excess return is a function of realized volatility. Best practice would involve modeling atm call purchases (married put synthetic) and test it empirically. Nobody knows what the cost will be.
Well, Mister Black Swan himself, Nassim Taleb, is very biased towards long options. His firm Empirica used only long far out of the money strangles (with dynamic hedging no doubt). He does admit this is quite an aggressive strategy.